Sem-6 FM GKJ (New Header & Footer)

Calcutta University
B.Com (3rd Year)
Semester - VI
Honours & General
Question & Answers
on
Financial Management
By
Gobind Kumar Jha
Ca (F). L.L.B(H)., M. Com (H)
Contents
Question 1 - 53
Theoretical
Question
Practical
53 - 98
Working Capital Management 54 - 62
Leverage 63 - 70
Cost of Capital 71 - 78
Basic Concept 79 - 82
Dividend Policies 83 - 86
Capital Budgeting 87 - 98
GOBIND KUMAR JHA
Question
Theoretical
Financial Management 9874411552
FINANCIAL MANAGEMENT
Theoretical Questions
1. Define Financial Management.
Introduction: One needs money to make money. Finance is the life-blood of business and there must be a
continuous flow of funds in and out of a business enterprise. Money makes the wheels of business run smoothly.
Sound plans, efficient production system and excellent marketing network are all hampered in the absence of an
adequate and timely supply of funds.
Sound financial management is as important in business as production and marketing. A business firm requires
finance to commence its operations, to continue operations and for expansion or growth. Finance is, therefore,
an important operative function of business.
Definition of Financial Management: Financial management may be defined as planning, organising,
directing and controlling the financial activities of an organisation.
According to Guthman and Dougal, financial management means, “the activity concerned with the planning,
raising, controlling and administering of funds used in the business.” It is concerned with the procurement and
utilisation of funds in the proper manner.
Ezra Solomon has described the nature of financial management as follows: “Financial management is properly
viewed as an integral part of overall management rather than as a staff specially concerned with funds raising
operations."
In addition to raising funds, financial management is directly concerned with production, marketing and other
functions within an enterprise whenever decisions are made about the acquisition or distribution of funds.
2. Discuss the importance of Financial Management.
Finance is the lifeblood of business organization. It needs to meet the requirement of the business concern. Each
and every business concern must maintain adequate amount of finance for their smooth running of the business
concern and also maintain the business carefully to achieve the goal of the business concern. The business goal
can be achieved only with the help of effective management of finance. We can’t neglect the importance of
finance at any time at and at any situation.
Some of the Importance of the financial management is as follows:
(a) Financial Planning: Financial management helps to determine the financial requirement of the business
concern and leads to take financial planning of the concern. Financial planning is an important part of the
business concern, which helps to promotion of an enterprise
(b) Acquisition of Funds: Financial management involves the acquisition of required finance to the business
concern. Acquiring needed funds play a major part of the financial management, which involve possible
source of finance at minimum cost.
(c) Proper Use of Funds: Proper use and allocation of funds leads to improve the operational efficiency of the
business concern. When the finance manager uses the funds properly, they can reduce the cost of capital and
increase the value of the firm.
(d) Financial Decision: Financial management helps to take sound financial decision in the business concern.
Financial decision will affect the entire business operation of the concern. Because there is a direct
relationship with various department functions such as marketing, production personnel etc.
(e) Improve Profitability: Profitability of the concern purely depends on the effectiveness and proper utilization
of funds by the business concern. Financial management helps to improve the profitability position of the
concern with the help of strong financial control devices such as budgetary control, ratio analysis and cost
volume profit analysis.
(f) Increase the Value of the Firm: Financial management is very important in the field of increasing the
wealth of the investors and the business concern. Ultimate aim of any business concern will achieve the
maximum profit and higher profitability leads to maximize the wealth of the investors as well as the nation.
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Gobind Kumar Jha 9874411552
(g) Promoting Savings: Savings are possible only when the business concern earns higher profitability and
maximizing wealth. Effective financial management helps to promoting and mobilizing individual and
corporate savings.
Now days financial management is also popularly known as business finance or corporate finances. The
business concern or corporate sectors cannot function without the importance of the financial management.
3. What are the functions of financial manager/Financial Management?
Financial Management means planning, organizing, directing and controlling the financial activities such as
procurement and utilization of funds of the enterprise. It means applying general management principles to
financial resources of the enterprise.
(a) Estimation of capital requirements: A finance manager has to make estimation with regards to capital
requirements of the company. This will depend upon expected costs and profits and future programmers
and policies of a concern. Estimations have to be made in an adequate manner which increases earning
capacity of enterprise.
(b) Determination of capital composition: Once the estimation have been made, the capital structure have
to be decided. This involves short- term and long- term debt equity analysis. This will depend upon the
proportion of equity capital a company is possessing and additional funds which have to be raised from
outside parties.
(c) Choice of sources of funds: For additional funds to be procured, a company has many choices like –
➢ Issue of shares and debentures
➢ Loans to be taken from banks and financial institutions
➢ Public deposits to be drawn like in form of bonds
Choice of factor will depend on relative merits and demerits of each source and period of financing.
(d) Investment of funds: The finance manager has to decide to allocate funds into profitable ventures so
that there is safety on investment and regular returns is possible.
(e) Disposal of surplus: The net profits decision has to be made by the finance manager. This can be done
in two ways.
(f) Dividend declaration: It includes identifying the rate of dividends and other benefits like bonus.
(g) Retained profits: The volume has to be decided which will depend upon expansional, innovational,
diversification plans of the company.
(h) Management of cash: Finance manager has to make decisions with regards to cash management. Cash
is required for many purposes like payment of wages and salaries, payment of electricity and water bills,
payment to creditors, meeting current liabilities, maintenance of enough stock, purchase of raw materials,
etc.
(i) Financial controls: The finance manager has not only to plan, procure and utilize the funds but he also
has to exercise control over finances. This can be done through many techniques like ratio analysis,
financial forecasting, cost and profit control, etc.
4. The activities of financial managers involve taking three important decisions. Briefly explain
these decisions?
The modern approach to the Financial Management is concerned with the solution of major problems like
investment financing and dividend decisions of the financial operations of a business enterprise. Thus, the
functions of Financial Management can be broadly classified into three major decisions, namely:
(a) Investment Decision: Investment Decision relates to the determination of total amount of assets to be held
in the firm, the composition of these assets and the business risk complexions of the firm as perceived by
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its investors. It is the most important financial decision. Since funds involve cost and are available in a
limited quantity, its proper utilisation is very necessary to achieve the goal of wealth maximisation.
The investment decisions can be classified under two broad groups:
(i) Long-term investment decision and
(ii) Short-term investment decision
The long-term investment decision is referred to as the capital budgeting and the short-term investment
decision as working capital management.
(b) Financing Decision: Once the firm has taken the investment decision and committed itself to new
investment, it must decide the best means of financing these commitments. Since, firms regularly make
new investments; the needs for financing and financial decisions are ongoing.
Hence, a firm will be continuously planning for new financial needs. The financing decision is not only
concerned with how best to finance new assets, but also concerned with the best overall mix of financing
for the firm.
A finance manager has to select such sources of funds which will make optimum capital structure.
Theimportant thing to be decided here is the proportion of various sources in the overall capital mix of the
firm. The debt-equity ratio should be fixed in such a way that it helps in maximising the profitability of the
concern.
The raising of more debts will involve fixed interest liability and dependence upon outsiders. It may help in
increasing the return on equity but will also enhance the risk.
The raising of funds through equity will bring permanent funds to the business but the shareholders will
expect higher rates of earnings. The financial manager has to strike a balance between various sources so
that the overall profitability of the concern improves.
If the capital structure is able to minimise the risk and raise the profitability then the market prices of the
shares will go up maximising the wealth of shareholders.
(c) Dividend Decision: The third major financial decision relates to the disbursement of profits back to
investors who supplied capital to the firm. The term dividend refers to that part of profits of a company
which is distributed by it among its shareholders.
It is the reward of shareholders for investments made by them in the share capital of the company. The
dividend decision is concerned with the quantum of profits to be distributed among shareholders.
A decision has to be taken whether all the profits are to be distributed, to retain all the profits in business or
to keep a part of profits in the business and distribute others among shareholders. The higher rate of
dividend may raise the market price of shares and thus, maximise the wealth of shareholders. The firm
should also consider the question of dividend stability, stock dividend (bonus shares) and cash dividend.
5. Discuss the nature of financial management.

Nature of financial management could be spotlighted with reference to the following aspects of this discipline:
a. Financial management is a specialized branch of general management, in the present-day- times. Long
back, in traditional times, the finance function was coupled, either with production or with marketing,
without being assigned a separate status.
b. Financial management is growing as a profession. Young educated persons, aspiring for a career in
management, undergo specialized courses in Financial Management, offered by universities, management
institutes etc.; and take up the profession of financial management.
c. Despite a separate status financial management, is intermingled with other aspects of management. To
some extent, financial management is the responsibility of every functional manager. For example, the
production manager proposing the installation of a new plant to be operated with modern technology; is
also involved in a financial decision.
d. Financial management is multi-disciplinary in approach. It depends on other disciplines, like Economics,
Accounting etc., for a better procurement and utilisation of finances.
e. The finance manager is often called the Controller; and the financial management function is given name
of controllership function; in as much as the basic guideline for the formulation and implementation of
plans-throughout the enterprise-come from this quarter.
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f. Despite a hue and cry about decentralisation of authority; finance is a matter to be found still centralised,
even in enterprises which are so called highly decentralised. The reason for authority being centralised, in
financial matters is simple; as every Tom, Dick and Harry manager cannot be allowed to play with
finances, the way he/she likes. Finance is both-a crucial and limited asset-of any enterprise.
g. Financial management is not simply a basic business function along with production and marketing; it is
more significantly, the backbone of commerce and industry. It turns the sand of dreams into the gold of
reality.
No production, purchases or marketing are possible without being duly supported by requisite finances.
Hence, Financial Management commands a higher status vis-a-vis all other functional areas of general
management.
6. What are the objectives of financial Management?

Objectives of financial management may be multiple; as this branch of general management encompasses
the entire organizational functioning.
For sake of analysis and better comprehension, the objectives of financial management might be classified
into certain categories-as depicted in form of the following:
(1) Basic Objectives
(i) Profit-Maximisation: Since time immemorial, the primary objective of financial management has been
held to be profit- maximisation. That is to say, that financial management ought to take financial decisions
and implement them in a way so as to lead the enterprise along lines of profit maximization. The support
for these objectives could be derived from the philosophy, that ‘profit is a test of economic efficiency’.
(ii) Wealth-Maximisation: Discarding the profit-maximisation objective; the real basic objective of
financial management, now-a- days, is considered to be wealth maximisation. Wealth maximisation is also
known as value- maximisation or the net present worth maximisation.
Since wealth of owners is reflected in the market-value of shares; wealth maximisation means the
maximisation of the market price of shares. Accordingly, wealth maximisation is measured, by the market
value of shares.
According to wealth maximisation objective, financial management must select those decisions, which
create most wealth for the owners. If two or more financial courses of action are mutually exclusive (i.e.
only one can be undertaken at a time); then that decision-which creates most wealth, must be selected.
The wealth arising from a financial course of action could be stated as follows:
Wealth = Gross present worth of a financial course of action minus amount of capital invested which is
required to achieve the benefits i.e. cash flows.
(2) Operational Objectives:
(i) Timely Availability of Requisite Finances: A very important operational objective of financial
management is to ensure that requisite funds are made available to all the departments, sections or units of
the enterprise at the needed time; so that the operational life of the enterprise goes smoothly.
(ii) Most Effective Utilization of Finances: Throughout the enterprise, the finances must be utilized most
effectively. This is yet, another important operational objective of the financial, management.
To ensure the attainment of this objective, the financial management must:
– Formulate plans for the most effective utilisation of funds, among channels of investment, which
create most wealth for the company.
– Exercise and enforce ‘financial discipline’ to prevent wasteful expenditure, by any department, or
branch or section of the enterprise.
(iii) Safety of Investment: The financial management must primarily look to the safety of investment i.e.
the channels of investment might bring in less returns; but investment must be safe. Loss of investment, in
any one line, might lead to capital depletion; and ultimately tell upon the financial health of the enterprise.
(iv) Growth of the Enterprise: The financial management must plan for the long-term stability and
growth of the enterprise. The limited finances of the enterprise must be so utilized that not only short run
benefits are available; but the enterprise grows slow and steady, in the long run also.
(3) Social Objectives:
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(i) Timely Payment of Interest: The financial management must see to it that interest on bonds,
debentures or other loans of the company is paid in time. This will not only keep the creditors satisfied with
the company adding to its goodwill; but also prevent any untoward consequences of the non-payment of
interest, in time.
(ii) Payment of Reasonable Dividends: An important social objective of financial management is that
shareholders i.e. the equity members of the company must get at least some regular dividends.
This objective is important for two reasons: –
– It helps the company maintain its competitive image, in the market. The members on whose funds the
company is running profitable operations must be duly compensated, as a matter of natural justice.
(iii) Timely Payment of Wages: The financial management must make a provision for a timely payment of
wages to workers. This is necessary to keep the labour force satisfied and motivated. Further, if wages are
paid on time; the legal consequences of non-payment of wages, under the ‘ Payment of Wages Act’, need
not frighten management.
(iv) Fair-Settlement with Suppliers: The financial management must make it a point to settle accounts
with suppliers and fellow- businessmen in time, in a fair way; otherwise the commercial reputation of the
enterprise will get a setback.
(v) Timely Payment of Taxes: An important objective of financial management would be to make timely
payment of taxes to the Government – so as to avoid legal consequences; and also fulfill its social
obligations towards the State.
(vi) Maintaining Relations with Financiers: The financial management must develop and maintain
friendly relations with financiers i.e. banks, financial institutions and various segments of the money
market and capital market. When good relations are maintained with financiers; they might come to the
rescue of the enterprise, in situations of financial crisis.
(4) Research Objectives: The successful attainment of various objectives by the financial management
requires it to follow a research approach. It must research into new and better sources of finances; and
also into new and better channels for the investment of finances.
This research objective of financial management requires it to:
– Collect financial data about the progress of its competitive counterparts.
– Make a study of money market and capital market operations, through a study of latest financial
magazines and other literature on financial management.
7. Why it is inappropriate to seek profit maximisation as the goal offinancial decision making?
Though, there could be little controversy over profit maximisation, as the basic objective of financial
management – yet, in the modern times, several authorities on financial management criticise this objective, on
the following grounds:
(i) Profit is a vague concept, in that; it is not clear whether profit means
– short-run or long-run profits.
– Profit before tax or profits after tax
– Rate of profits or the amount of profits
(ii) The profit maximisation objective ignores, what financial experts call the time value of money’. To
illustrate, this concept, let us assume that two financial courses of action provide equal benefits (i.e. profits)
over a certain period of time. However, one alternative gives more profits in earlier years; while the other
one gives more profits in later years.
Based on profit maximization criterion, both alternatives are equally well. However, the first alternative
i.e. the one which gives more profits in earlier years is better; as some part of the profits received earlier could
be reinvested also.
Modern financial experts call this philosophy, ‘the earlier the better principle’. The second alternative which
gives more profits only in later years is inferior; as the time-value of profits is more in the case of the first
alternative.
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(iii) The profit maximization objective ignores the quality of benefits (i.e. profits). The factor implicit here, is
the risk element associated with profits. Quality of benefits (profits) is the most when risk associated with their
occurrence is the least. According to modern financial experts, less profit with less risk are superior to more
profits with more risk.
(iv) Profit-maximisation objective is lop-sided. This objective considers or rather over-emphasizes only on the
interests of owners. Interests of other parties like, workers, consumers, the Government and the society as a
whole are ignored, under this concept of profit-maximisation.
8. Why value maximisation (wealth maximisation) objective is called better than profit
maximisation objectives?
The wealth maximisation objective is held to be superior to the profit maximisation objective, because of the
following reasons:
(a) It is based on the concept of cash flows; which is more definite than the concept of profits. Moreover,
management is more interested in immediate cash flows than the profits a large part of which might be
hidden in credit sales- still to be realized.
(b) Through discounting the cash flows arising from a financial course of action over a period of time at an
appropriate discount rate; the wealth maximisation approach considers both- the time value of money and
the quality of benefits.
(c) Wealth maximisation objective is consistent with the long-term profitability of the company.
9. Give an idea about ‘wealth maximisation’ & Profit Maximisation objective offinancial
management?
Wealth Maximization: -
Wealth Maximization is considered as the appropriate objective of an enterprise. When the firms
maximizes the stock holder’s wealth, the individual stockholder can use this wealth to maximize his
individual utility. Wealth Maximization is the single substitute for a stock holder’s utility.
A Stock holder’s wealth is shown by:
Stock holder’s wealth = No. of shares owned x Current stock price per share Higher the stock price per
share, the greater will be the stock holder’s wealth.
Arguments in favour of Wealth Maximization:
(i) Due to wealth maximization, the short-term money lenders get their payments in time.
(ii) The long-time lenders to get a fixed rate of interest on their investments.
(iii) The employees share in the wealth gets increased.
(iv) The various resources are put to economical and efficient use.
Argument against Wealth Maximization:
(i) It is socially undesirable.
(ii) It is not a descriptive idea.
(iii) Only stock holders wealth maximization does not lead to firm’s wealth maximization.
(iv) The objective of wealth maximization is endangered when ownership and management are separated.
Inspite of the arguments against wealth maximization, it is the most appropriative objective of a firm
Profit Maximization:
Profit Maximization is the main objective of business because:
(i) Profit acts as a measure of efficiency and
(ii) It serves as a protection against risk.
Agreements in favour of Profit Maximization:
(i) When profit earning is the main aim of business the ultimate objective should be profit maximization.
(ii) Future is uncertain. A firm should earn more and more profit to meet the future contingencies.
(iii) The main source of finance for growth of a business is profit. Hence, profit maximization is required.
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(iv) Profit maximization is justified on the grounds of rationality as profits act as a measure of efficiency
and economic prosperity.
Arguments against Profit Maximization:
(i) It leads to exploitation of workers and consumers.
(ii) It Ignores the risk factors associated with profit.
(iii) Profit in itself is a vague concept and means differently to different people.
(iv) It is narrow concept at the cost of social and moral obligations.
Thus, profit maximization as an objective of Financial Management has been considered inadequate.
10. What are Limitations of ‘Maximisation of Profit’ as the objective of a firm.

Profit maximization is criticized for some of its limitations which are discussed below:
The haziness of the concept “profit” The term “Profit” is a vague term. It is because different mindset will
have a different perception of profit. For e.g. profits can be the net profit, gross profit, before tax profit, or the
rate of profit etc. There is no clearly defined profit maximization rule about the profits.
Ignores time value of money: The profit maximization formula simply suggests “higher the profit better is the
proposal”. In essence, itis considering the naked profits without considering the timing of them. Another
important dictum of finance says “a dollar today is not equal to a dollar a year later”. So, the time value of
money is completely ignored.
Ignores the risk: A decision solely based on profit maximization model would take a decision in favor of
profits. In the pursuit of profits, the risk involved is ignored which may prove unaffordable at times simply
because higher risks directly questions the survival of a business.
Ignores quality The most problematic aspect of profit maximization as an objective is that it ignores the
intangible benefits such as quality, image, technological advancements etc. The contribution of intangible
assets in generating value for a business is not worth ignoring. They indirectly create assets for the
organization. Profit maximization ruled the traditional business mindset which has gone through drastic
changes. In the modern approach of business and financial management, much higher importance is assigned
to wealth maximization in comparison of Profit Maximization vs. Wealth Maximization. The losing
importance of profit maximization is not baseless and it is not only because it ignores certain important are as
such as risk, quality, and the time value of money but also because of the superiority of wealth maximization
as an objective of the business or financial management.
11. Distinguish Between Profit maximization & wealth maximization
Profit Maximisation Wealth Maximisation

It is traditional approach of the financial It is modern approach of the financial
management. management.
According to this criterion, the financial activities According to this criterion, the financial activities
of a firm are conducted in such a way so that the of a firm are conducted in such a way so that the net
amount of profit of the firm is maximum. wealth of the firm is maximum.
The concept of profit is not clear in the profit The concept of wealth is clear in the wealth
maximisation criterion. maximisation criterion. In this case wealth
refers to the net present value of a project.
The aspects of risk and uncertainty are The aspects of risk and uncertainty are considered
ignored in profit maximisation criterion. in wealth maximisation criterion,
In this case, it is not necessary to know the In this case, it is necessary to know the rate of
rate of discount for determining the profit. discount for determining the net wealth.
Time value of money is not considered in this Time value of money is considered in this
criterion. Criterion
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It measures the performance of a business firm It measures the performance of a business firm on
only on the basis of its profit. the basis of the shareholders’ wealth (or the
current market price of the equity shares).
It is based on the assumption of perfect It assumes an efficient capital market.
competition in the product market.
It does not also consider the impacts of earnings It takes into account the present value of the
per share, dividend payments and other returns future cash inflows, dividend payments, earnings
to the shareholders on shareholder’s wealth or on per share and their influence on shareholders’
the value of the firm. wealth.
A firm may not pay regular dividends to its A firm pays regular dividends to its
shareholders and reinvest its retained earning to shareholders to achieve this goal.
achieve this goal.
There remains some ambiguity in the definition There remains some ambiguity in the definition of
of profits of a firm (e.g., profit before tax or ‘wealth’, i.e., whether it should be shareholders’
profits after tax) wealth of the ‘wealth of a firm’ (which includes
other financial claimholders such as
bondholders,
Preference shareholders etc.)
The conflict among the goals of owners and The divorce between management and owners in
management may stand in the way of achieving any corporate firm can also frustrate the goal of
this goal wealth maximization.
The role of the CFO (Chief Financial Officer) has been changing over the past twenty years. Originally, the role
of the CFO revolved around producing and analysing the financial statements. However, because of the
computerization of the accounting function the need for accounting skills in performing the roles and
responsibilities of a CFO diminished. Though the job description of a CFO (Chief Financial Officer) remains
broad the tasks comprising that function fall into four distinct roles.
The Strategist CFO The first role of the CFO is to be a strategist to the CEO. The traditional definition of
success for a chief financial officer was reporting the numbers, managing the financial function, and being
reactive to events as they unfold. But in today’s fast paced business environment, producing financial reports
and information is no longer enough. CFO’s in the twenty-first century must be able to “peak around corners”.
Therefore, they must be able to apply critical thinking skills, along with financial acumen, to the long-term
goals of the organization.
The CFO as a Leader The second role of the CFO hand in hand with the first one. That is one of a leader
implementing the strategies of the company. As a result, it is no longer sufficient for a CFO to sit back and
analyze the effort of others. The chief financial officer (CFO) of today must take ownership of the financial
results the organization and senior management team.
The chief financial officer of today must be responsible for providing leadership to other senior management
team members, including the CEO. The CFO’s role can sometimes force them to make the tough calls that
others in the organization don’t or can’t make. Occasionally, this can mean the difference between success and
failure.
The CFO as a Team Leader The third role of the CFO is that of a team leader to other employees – both inside
and outside of the financial function. Not only will a coach call plays for a team, but they are also responsible
for getting the highest results out of the talent on their team.
An aspiring and successful coach will produce superior results by finding the strengths of their team members
and obtaining a higher level of performance than the individuals might achieve on their own. The role of the
CFO (Chief Financial Officer) is to bring together a diverse group of talented individuals to achieve superior
financial performance.
The CFO with Third Parties Last, but not least, the role of the CFO is that of a diplomat to third parties.
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People outside of the company look to senior management team for inspiration and confidence in the company’s
ability to perform. In almost every case the financial viability of the company is vouched for by the CFO.
The CFO’s role becomes that of the “face” of the company’s sustainability to customers, vendors and
bankers. Often these third parties look to the CFO for the unvarnished truth regarding the financial viability of
the company to deliver on it’s brand promise.
Today’s Role of the CFO In today’s fast paced environment the role of the CFO is extremely fluid. One day
the CFO might be developing a compensation plan for employees. Then the next day taking their bankers on a
tour of the facilities. Consequently, to be a successful CFO in the future you must be a more multi-functional
executive with financial skills.
12. What is time value of money? What is its importance in long term financial decisionmaking?
What is time value of money can be easily understand from the following example:
If we are offered the choice between having ₹ 100 today and having ₹ 100 at a future date, we will usually
prefer to have ₹ 100 now. If the choice is between paying ₹ 100 now or paying the same ₹ 100at a future date,
we will usually prefer to pay ₹ 100 later. But why is this? ₹ 100 has the same value one year from now also.
Actually, although the value is the same, we can do much more with the money if you have it now; over the
time we can earn some interest on our money.
The time value of money (TVM) is one of the basic concepts of finance. We know that if we deposit money in
a bank account we will receive interest. Because of this, we prefer to receive money today rather than the same
amount in the future. Money we receive today is more valuable to us than money received in the future by the
amount of interest we can earn with the money. This is referred to as the time value of money.
The term time value of money can be defined as “The value derived from the use of money over time as a
result of investment and reinvestment.
The reason why there is time value of money is as follows:
(a) Inflation: Under inflationary conditions the value of money expressed in terms of its purchasing power
over goods and services declines.
(b) Risk: Having one rupee now is certain where as one rupee receivable tomorrow is less certain. That is a
bird-in-the-hand principle is most important in the investment decisions.
(c) Personal Consumption Preference: Many individuals have a strong preference for immediate rather than
delayed consumption. The promise of a bowl of rice next week counts for little to the starving man.
(d) Investment Opportunities: Money like any other commodity has a price. Given the choice of ` 1000/-
now or the same account in one year time, it is always preferable to take ` 1000/- now, because it could be
invested over the next year @ 12% interest, to produce ` 1,120/- at the end of year. If the risk-free rate of
return in 12%, then you would be indifferent in receiving ` 1000/- now or `1120/- in ones years’ time. In
other words, the present value of `1120/- receivable one year hence is `1000/-.
13. Explain the compounding & discounting technique in relation to time value ofmoney?
Technique of discounting: The present value of a sum of money to be received at a future date is determined
by discounting the future value at the interest rate that the money could earn over the period. This process is
known as Discounting. The present value interest factor declines as the interest rate rises and as the length of
time increases.
Techniques of compounding: The "time value of money" describes the effects of compounding. An amount
invested today has more value than the same amount invested at a later date because it can utilize the power of
compounding. Compounding is the process by which interest is earned on interest. When a principal amount is
invested, interest is earned on the principal during the first period or year. In the second period or year, interest
is earned on the original principal plus the interest earned in the first period. Over time, this reinvestment
process can help an account grow significantly.
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14. In which techniques time is adjusted with the value of money?
Present value is the exact opposite of compound or future value. While future value shows how much
a sum of money becomes at some future period, present value shows what the value is today of some future sum of
money. In compound or future value approach the money invested today appreciates because the compound interest
is added to the principal.
The present value of money to be received on future date will be less because we have lost the opportunity of investing
it at some interest. Thus, the present value of money to be received in future will always be less. It is for this reason
that the present value technique is called discounting.
15. Define risk. Classify risks associated with financial management.

Risk and Types of Risks: Risk can be referred as the chances of having an unexpected or negative outcome.
Any action or activity that leads to loss of any type can be termed as risk. There are different types of risks that a
firm might face and needs to overcome. Widely, risks can be classified into three types: Business Risk, Non-
Business Risk and Financial Risk.
(a) Business Risk: These types of risks are taken by business enterprises themselves in order to maximize
shareholder value and profits. As for example: Companies undertake high cost risks in marketing to launch
new product in order to gain higher sales.
(b) Non- Business Risk: These types of risks are not under the control of firms. Risks that arise out of
political and economic imbalances can be termed as non-business risk.
(c) Financial Risk: Financial Risk as the term suggests is the risk that involves financial loss to firms. Financial
risk generally arises due to instability and losses in the financial market caused by movements in stock prices,
currencies, interest rates and more.
Types of Financial Risks: Financial risk is one of the high-priority risk types for every business. Financial
risk is caused due to market movements and market movements can include host of factors. Based on this,
financial risk can be classified into various types such as Market Risk, Credit Risk, Liquidity Risk,
Operational Risk and Legal Risk.
Market Risk: This type of risk arises due to movement in prices of financial instrument. Market risk can
be classified as Directional Risk and Non - Directional Risk. Directional risk is caused due to movement in
stock price, interest rates and more. Non- Directional risk on the other hand can be volatility risks.
Credit Risk: This type of risk arises when one fails to full fill their obligations towards their counter parties.
Credit risk can be classified into Sovereign Risk and Settlement Risk. Sovereign risk usually arises due to
difficult foreign exchange policies. Settlement risk on the other hand arises when one party makes the
payment while the other party fails to full fill the obligations.
Liquidity Risk: This type of risk arises out of inability to execute transactions. Liquidity risk can
be classified into Asset Liquidity Risk and Funding Liquidity Risk. Asset Liquidity risk arises either due to
insufficient buyers or insufficient sellers against sell orders and buy orders respectively.
Operational Risk: This type of risk arises out of operational failures such as mismanagement or technical
failures. Operational risk can be classified into Fraud Risk and Model Risk. Fraud risk arises due to lack of
controls and Model risk arises due to incorrect model application.
Legal Risk: This type of financial risk arises out of legal constraints such as lawsuits. Whenever a company
needs to face financial loses out of legal proceedings, it is legal risk.
16. Discuss the relationship between Risk and Return.
The risk and return constitute the framework for taking investment decision. It has generally been found that
there is a direct relationship between risk and return. An investment proposal involving low risk has low return
while a proposal involving higher risk has higher return.
Relationship between risk and return means to study the effect of both elements on each other. We measures the
effect of increase or decrease risk on return of investment. Following is the main type of relationship of risk
and return.
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1. Direct Relationship between Risk and Return
(a) High Risk - High Return According to this type of relationship, if investor will take more risk, he
will get more reward. So, he invested million, it means his risk of loss is million dollar. Suppose, he is
earning 10% return. It means, his return is Lakh but he invests more million, it means his risk of
loss of money is million. Now, he will get Lakh return.
(b) Low Risk - Low Return It is also direct relationship between risk and return. If investor decreases
investment. It means, he is decreasing his risk of loss, at that time, his return will also decrease.
2. Negative Relationship between Risk and Return
(a) High Risk Low Return Sometime, investor increases investment amount for getting high return but
with increasing return, he faces low return because it is nature of that project. There is no benefit to
increase investment in such project. Suppose, there are 1,00,000 lotteries in which you will earn the
prize of You have bought 50% of total lotteries. But, if you buy 75% of lotteries. Prize will same but
at increasing of risk, your return will decrease.
(b) Low Risk High Return There are some projects, if you invest low amount, you can earn high return.
For example, Govt. of India need money. Because, govt. needs this money in emergency and Govt. is
giving high return on small investment. If you get this opportunity and invest your money, you will get
high return on your small risk of loss of money.
17. What is capital Budgeting? What are the Purposes of Capital Expenditure Decisions:
Capital budgeting decision may be defined as “Firms decisions to invest its current funds most efficiently in
long term activities in anticipation of an expected flow of future benefits over a series of year. The firm’s
capital budgeting decisions will include addition, disposition, modification and replacement of fixed assets”.
Definitions:
Charles. T. Horngreen defined capital budgeting as “Long term planning for making and financing proposed
capital out lay”.
According to Keller and Ferrara, “Capital Budgeting represents the plans for the appropriation and expenditure
for fixed asset during the budget period”.
Robert N. Anthony defined as “Capital Budget is essentially a list of what management believes to be
worthwhile projects for the acquisition of new capital assets together with the estimated cost of each product”.
Need of capital budgeting decision
The selection of the most profitable project of capital investment is the key function of Financial Manager.
The decisions taken by the management in this area affect the operations of the firm for many years Capital
budgeting decisions may be generally needed for the following purposes:
Hence, following may be considered as major or specific objectives in respect of investment in fixed assets
under long-term basis:
(a) Modification and Replacement of existing facilities.
(b) Quality improvement in the present projects.
(c) Expansion of business through creating additional facilities.
(d) Creation of new product and improving the quality of existing products.
(e) Product diversification for survival under the competitive market scenario.
(f) Cost reduction initiatives which may require the purchase of most sophisticated and modern equipment.
(g) Exploration of new ideas through Research and Development.
(h) Replacement of manual work by automation process.
(i) Maximization of wealth of the shareholder.
(j) Achievement of various social objectives complying with statutory obligations. (say, setting up of waste
treatment plant to reduce environmental pollution).
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18. What do you mean by capital budgeting? Discuss its importance.
Financing and investment of funds are two crucial financial functions. The investment of funds also termed as
capital budgeting requires a number of decisions to be taken in a situation in which funds are invested and
benefits are expected over a long period. The term capital budgeting means planning for capital assets. It
involves proper project planning and commercial evaluation of projects to know in advance technical
feasibility and financial viability of the project.
Importance of Capital Budgeting
Capital Budgeting decisions are considered important for a variety of reasons. Some of them are the following:
(a) Crucial decisions: Capital budgeting decisions are crucial, affecting all the departments of the firm. So the
capital budgeting decisions should be taken very carefully.
(b) Long-run decisions: The implications of capital budgeting decisions extend to a longer period in the
future. The consequences of a wrong decision will be disastrous for the survival of the firm.
(c) Large amount of funds: Capital budgeting decisions involve spending large amount of funds. As such
proper care should be exercised to see that these funds are invested in productive purchases.
(d) Rigid: Capital budgeting decision can not be altered easily to suit the purpose. Because of this reason,
when once funds are committed in a project, they are to be continued till the end, loss or profit no matter.
19. What are the process (Steps) of capital budgeting?
The major steps in the capital budgeting process are given below. They are a) Generation of project;
b) Evaluation of the project; c) Selection of the project and d) Execution of the project. The capital budgeting
process may include a few more steps. As each step is significant, they are usually taken by top management
(a) Generation of Project: Depending upon the nature of the firm, investment proposals can emanate from a
variety of sources. Projects may be classified into five categories.
(i) New products or expansion of existing products.
(ii) Replacement of equipment or buildings.
(iii) Research and development.
(iv) Exploration.
(v) Others like acquisition of a pollution control device etc.
Investment proposals should be generated for the productive employment of firm’s funds. However, a
systematic procedure must be evolved for generating profitable proposals to keep the firm healthy.
(b) Evaluation of the project: The evaluation of the project may be done in two steps. First the costs and
benefits of the project are estimated in terms of cash flows and secondly the desirability of the project is
judged by an appropriate criterion. It is important that the project must be evaluated without any prejudice on
the part of the individual. While selecting a criterion to judge the desirability of the project, due consideration
must be given to the market value of the firm.
(c) Selection of the project: After evaluation of the project, the project with highest return should be selected.
There is no hard and fast rule set for the purpose of selecting a project from many alternative projects.
Normally the projects are screened at various levels. However, the final selection of the project vests with the
top-level management.
(d) Execution of project: After selection of a project, the next step in capital budgeting process is to
implement the project. Thus, the funds are appropriated for capital expenditures. The funds are spent in
accordance with appropriations made in the capital budget funds for the purpose of project execution should
be spent only after seeking format permission for the controller. The follow – up comparison of actual
performance with original estimates ensures better control.
Thus, the top management should follow the above procedure before taking actual expenditure decision.
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20. Discuss the different Types of Investment Projects.
Firms generally classify their investment project into the project into the following categories for carrying out
the screening process as stated in our earlier section:
(a) Replacement for the maintenance of business: This involves expenditure for replacing worn- out or
damaged capital and equipment used to produce some profitable products.
(b) Replacement for cost reduction: Investment required to replace working but obsolete equipment with
modern equipment, which are supposed to reduce the average cost of production (say, by reducing the labour
costs, material costs, electricity and fuel costs, etc.), fall into this category.
(c) Expansion of output of some traditional products and their markets: Investment needed to expand the
production of some traditional products of a firm in their existing or traditional markets, are included in this
category. These investment projects may be taken up in response to increase demand for such products, say, in
the domestic market.
(d) Search for new markets and increase in the production of non-traditional products: In a fast-changing
business world, the efficient operation of a firm also requires investment in developing new products and
expanding the market for such products, both in the domestic and external fronts.
(e) Complying with statutory obligations: These investment projects include such investments which are
required by any firm to fulfill some statutory obligations like population control, health and safety regulations,
etc. imposed by the Government.
21. Discuss briefly the NPV method of evaluation of projects.

NPV method
The net present value method is a classic method of evaluating the investment proposals. It is one of the
methods of discounted cash flow techniques, which recognizes the importance of time value of money. It
correctly postulates that cash flows arising at time periods differ in value and are comparable only with their
equivalents i.e. present values.
It is a method of calculating the present value of cash flows (inflows and outflows) of an investment proposal
using the cost of capital as an appropriate discounting rate. The net present value will be arrived at by
subtracting the present value of cash outflows from the present value of cash inflows.
According to Ezra Soloman, “it is a present value of the cast of the investment.”
Acceptance Rule:
If the NPV is positive or at-least equal to zero, the project can be accepted. If it is negative, the proposal can be
rejected. Among the various alternatives, the project which gives the highest positive NPV should be selected.
NPV is positive = Cash inflows are generated at a rate higher than the minimum required by the firm. NPV is zero
= Cash inflows are generated at a rate equal to the minimum required.
NPV is negative = Cash inflows are generated at a rate lower than the minimum required by the firm. The market
value per share will increase if the project with positive NPV is selected.
The accept/reject criterion under the NPV method can also be put as:
Merits:
The following are the merits of the net present value (NPV) methods:
(a) Consideration to total Cash Inflows: The NPV methods considers the total cash inflows of investment
opportunities over the entire life-time of the projects unlike the payback period methods.
(b) Recognition to the Time Value of Money: This method explicitly recognizes the time value of money,
which is investable for making meaningful financial decisions.
(c) Changing Discount Rate: Due to change in the risk pattern of the investor different discount rates can be
used.
(d) Best decision criteria for Mutually Exclusive Projects: This Method is particularly useful for the selection
of mutually exclusive projects. It serves as the best decision criteria for mutually exclusive choice proposals.
(e) Maximisation of the Shareholders Wealth: Finally, the NPV method is instrumental in achieving the
objective of the maximization of the shareholders’ wealth. This method is logically consistent with the
company’s objective of maximizing shareholders’ wealth in terms of maximizing market value of shares, and
theoretically correct for the selections of investment proposals.
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Demerits:
The following are the demerits of the net present value method:
(a) It is difficult to understand and use.
(b) The NPV is calculated by using the cost of capital as a discount rate. But the concept of cost of capital itself
is difficult to understand and determine.
(c) It does not give solutions when the comparable projects are involved in different amounts of investment.
(d) It does not give correct answer to a question when alternative projects of limited funds are available, with
unequal lives.
22. Discuss briefly IRR method of evaluation of projects.

IRR method follows discounted cash flow technique which takes into account the time value of money. The
internal rate of return is the interest rate which equates the present value of expected future cash inflows with the
initial capital outlay. In other words, it is the rate at which NPV is equal zero.
Whenever a project report is prepared, IRR is to be worked out in order to ascertain the viability of the project.
This is also an important guiding factor to financial institutions and investor.
Acceptance Rule
If the internal rate of return exceeds the required rate of return, then the project will be accepted. If the project’s
IRR is less than the required rate of return, it should be rejected. In case of ranking the proposals the technique of
IRR is significantly used. The projects with highest rate of return will be ranked as first compared to the lowest
rate of return projects.
Thus, the IRR acceptance rules are Accept if IRR > k
Reject if IRR < k
May accept or reject if IRR = k Where
K is the cost of capital
MERITS:-
The following are the merits of the IRR method:
(a) Consideration of Time of Money: It considers the time value of money.
(b) Consideration of total Cash Flows: It taken into account the cash flows over the entire useful life of the
asset.
(c) Maximizing of shareholders’ wealth: It is in conformity with the firm’s objective of maximizing owner
welfare.
(d) Provision for risk and uncertainty: This method automatically gives weight to money values which are
nearer to the present period than those which are distant from it. Conversely, in case of other methods like
‘Payback Period’ and ‘Accounting Rate of Return’, all money units are given the same weight which is
unrealistic. Thus the IRR is more realistic method of project valuation. This method improves the quality of
estimates reducing the uncertainty to minimum.
(e) Elimination of pre-determined discount rate: Unlike the NPV method, the IRR method eliminates the use
of the required rate of return which is usually a pre-determined rate of cost of capital for discounting the cash
flow consistent with the cost of capital. Therefore, the IRR is more reliable measure of the profitability of the
investment proposals.
DEMERITS:-
The following are the demerits of the IRR:
(a) It is very difficult to understand and use
(b) It involves a very complicated computational work
(c) It may not give unique answer in all situations
(d) The assumption of re-investment of cash flows may not be possible in practice.
(e) In evaluating the mutually exclusive proposals, this method fails to select the most profitable project which is
consistent with the objective of maximization of shareholders wealthy.
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23. Compare between Internal Rate of Return & Net Present Value.
Comparison of both the techniques
(a) Both techniques use Discounted Cash Flow (DCF) method.
(b) Both recognize the time value of money.
(c) Both take into account the cash flows over the entire life of the project.
(d) Both are consistent with the objective of maximizing the wealth of shareholders
(e) Both are difficult to calculate.
(f) Both techniques may often give contradictory result in the case of alternative proposals which are mutually
exclusive.
Contrast, i.e. Points of difference
(a) Interest Rate: NPV uses the firm’s cost of capital as Interest Rate. Unless the cost of capital is known, NPV
method cannot be used. Calculating cost of capital is not required for computing IRR.
(b) NPV may mislead when dealing with alternative projects or limited funds under the conditions of unequal
lives. IRR allows a sound comparison of the project having different lives and different timings of cash
inflows.
(c) NPV may give different ranking in case of complicated projects as compared to IRR method.
(d) NPV assumes that intermediate cash flows are re-invested at firm’s cost of capital whereas IRR assumes that
intermediate cash inflows are reinvested at the internal rate of the project.
(e) The results of IRR method may be inconsistent compared to NPV method, if the projects differ in their (a)
expected lives or (b) investment or (c) timing of cash inflow.
(f) IRR method favors short-lived project so long as it promises return in excess of cut-off rate whereas NPV
method favors long-lived projects.
(g) Sometimes IRR may give negative rate or multiple rates. NPV does not suffer from the limitation of multiple
rates.
Recommendation
The NPV method is generally considered to be superior theoretically because:
It is simple to calculate as compared to IRR.
(a) It does not suffer from the limitation of multiple rates.
(b) NPV assumes that intermediate cash flows are reinvested at firm’s cost of capital.
The reinvestment assumption of NPV is more realistic than IRR method.
But IRR method is favoured by some scholars because:
(a) It is easier to visualize and to interpret as compared to NPV.
(b) Even in the absence of cost of capital, IRR gives an idea of project’s profitability.
(c) Unless the cost of capital is known, NPV cannot be used.
(d) IRR method is preferable to NPV in the evaluation of risky projects.
24. Examine the rationality of the Payback Period Method in the context of capital expenditure
decisions.
Payback Period: -
It is the most popular and widely recognized traditional methods of evaluating the investment proposals. It can be
defined as “the number of years to recover the original capital invested in a project”. According to Weston and
Brigham, “the payback period is the number of years it takes for the firm to recover its original investment by net
returns before depreciation, but after taxes:
When cash flows are uniform:
If the proposed project’s cash inflows are uniform the following formula can be used to calculate the payback
period.
Payback period = Annual Cash inflows/Initial Investment
When cash flows are not uniform:
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When the project’s cash inflows are not uniform, but vary from year to year pay back period is calculated by
the process of cumulating cash inflows till the time when cumulative cash flows become equal to the original
investment outlay.
Discounted payback period’
Some Accountants calculate payback period after discounting the cash flows by a predetermined rate and the
payback period so calculated is called, ‘Discounted payback period’.
Advantages of Payback period:
Merits: The following are the merits of the payback period method:
(a) Easy to calculate: It is one of the easiest methods of evaluating the investment projects. It is simple to
understand and easy to compute.
(b) Knowledge: The knowledge of payback period is useful in decision-making, the shorter the period better the
project.
(c) Protection from loss due to obsolescence: This method is very suitable to such industries where mechanical
and technical changes are routine practice and hence, shorter payback period practice avoids such losses.
(d) Easily availability of information: It can be computed on the basis of accounting information, what is
available from the books.
Limitations of Payback period:
However, the payback period method has certain demerits:
(a) Failure in taking cash flows after payback period: This method is not taking into account the cash flows
received by the company after the payback period.
(b) Not considering the time value of money: It does not take into account the time value of money.
(c) Non-considering of interest factor: It does not take into account the interest factor involved in the capital
outlay.
(d) Maximisation of market value not possible: It is not consistent with the objective of maximizing the market
value of share.
(e) Failure in taking magnitude and timing of cash inflows: It fails to consider the pattern of cash inflows i.e.
the magnitude and timing of cash inflows.
25. Write short note on Accounting Rate of Return Method.

Accounting Rate of Return
This technique uses the accounting information revealed by the financial statements to measure the profitability of
an investment proposal. It can be determined by dividing the average income after taxes by the average
investment. According to Soloman, Accounting Rate of Return can be calculated as the ratio, of average net
income to the initial investment.
On the basis of this method, the company can select all those projects whose ARR is higher than the minimum rate
established by the company. It can reject the projects with an ARR lower than the expected rate of return. This
method also helps the management to rank the proposal on the basis of ARR.
Accounting Rate of Return (ARR) = Original Investment/Average Net Income
Acceptance Rule:
The project which gives the highest rate of return over the minimum required rate of return is acceptable
Merits:
The following are the merits of ARR method:
(a) It is very simple to understand and calculate;
(b) It can be readily computed with the help of the available accounting data;
(c) It uses the entire stream of earnings to calculate the ARR.
Demerits:
This method has the following demerits:
(a) It is not based on cash flows generated by a project;
(b) This method does not consider the objective of wealth maximization;
(c) It ignores the length of the project’s useful life;
(d) If does not take into account the fact that the profile can be re-invested; and
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(e) It ignores the time value of money.
26. Write short note on Profitability Index Method.

This method is also known as ‘Benefit Cost Ratio’. According to Van Horne, the profitability Index of a project is
“the ratio of the present value of future net cash inflows to the present value of cash outflows”.
Profitability Index = Present value of cash inflows/Present value of cash outflows
Advantages
Decision criteria: If the Profitability Index is greater than or equal to one, the project should be accepted
otherwise reject.
Merits:
The merits of this method are:
(a) It takes into account the time value of money
(b) It helps to accept / reject investment proposal on the basis of value of the index.
(c) It is useful to rank the proposals on the basis of the highest /lowest value of the index.
(d) It takes into consideration the entire stream of cash flows generated during the life of the asset.
Demerits:
However, this technique suffers from the following limitations:
(a) It is somewhat difficult to compute.
(b) It is difficult to understand the analytical of the decision on the basis of profitability index.
27. Modified Internal Rate of Returns (MIRR)

IRR assumes that interim positives cash flows are reinvested at the rate of returns as that of the project that
generated them. This is usually an unrealistic scenario. To overcome this draw back a new technique emerges.
Under MIRR the earlier cash flows are reinvested at firm’s rate of return and finding out the terminal value. MIRR
is the rate at which present value of terminal values equal to outflow (Investment).
The procedure for calculating MIRR is as follows:
Step I: Calculate the present value of the costs (PVC) associated with the project, using cost of capital
(r) as the discount rate.
Step 2: Calculate the future value (FV) of the cash inflows expected from the project:
Step 3: Obtain MIRR
∑ CV of all CIAT−1
MIRR= √ ∑ PV of all CO
Merits of MIRR method:
(a) It takes into account the time value of money.
(b) This method also considers the net cash flow stream over the life-span of the investment project.
(c) The approach of this method is very straight forward, simple, quick and easy to understand.
(d) MIRR assumes that positive cash flows are reinvested at the rate equivalent to firm’s cost capital, and hence
gives a more realistic evaluation of the project.
(e) Any series of cash flows has a single MIRR.
Demerits of the MIRR method:
The MIRR does suffer from some of the drawbacks of IRR. Relying on it can lead to an incorrect choice
between mutually exclusive investments. The MIRR cannot be validly used to rank-order projects of different
sizes because a larger project with a smaller MIRR may have a higher present value.
28. Write Short Notes on Capital Rationing

Capital Rationing means distribution of limited Capital in favour of more acceptable proposals. It refers to a
situation where a firm is not in a position to invest in all profitable projects due to the limited financial
resources in the form of capital. In other words, under this situation, a firm is compelled to reject some of the
firm of the viable projects having positive net present value because of shortage of funds. Therefore, the firm
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has to select a feasible combination of proposals that will give the maximum return to the wealth of
shareholders by maximising the total net present value from the available projects.
In this section we shall discuss the methods of solving the capital budgeting problems under the situation of
capital rationing. This can be studied under the following two situations:
1. When projects are Divisible: It means projects can be taken up (i.e., accepted or rejected) in parts.
2. When project are Indivisible: It means projects can be taken up in totality and the part acceptance or
rejection is not possible.
Practical Questions
B. Com (Hons.) 2017
1. Discuss the nature and objectives of financial management.

2. Why value maximization objective is called better than profit maximization objective? or why will be the role
of CFO in the financial crisis of an organization?
3. X borrows 59,36,000 from Y at a compound interest rate of 12% p.a. It is agreed that the loan shall be payable
in two equal instalments, which shall be payable at the end of the 1st year and 2nd year respectively. Calculate
the number of instalments.
4. Mr. H is offered either to receive ₹10,000 three years from now or 2,14,000 five years from now. Which one Mr.
H will accept? Assume rate of discount is 10%. [Given: Present value of ₹1 at 10% are 0.751 and 0.621 for 3rd
and 5th year respectively] or write in brief about the financial environment of the business.
5. A project of 3,00,000 is supposed to yield 40,000 after depreciation @12.5% and is subject to income tax @ 40%.
Calculate the Payback period of the project. or write demerits of Pay Back Period method of project evaluation.
6. Based on the following information, which project will you select and why?
Project I Project II Project III
Year Earning Depreciation Earning Depreciation Earning Depreciation

after Tax after Tax after Tax
1 20,000 3,000 50,000 5,000 35,000 4,000
2 30,000 2,000 40,000 4,500 35,000 4,000
3 40,000 2,500 30,000 4,000 35,000 4,000
Assuming tax rate of 50% and discount rate as 10%.
[Given: PV of 1 at 10% discount Y, 0.909; Y, 0.826 and Y, 0.751]
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7. Estimate the working capital requirement on profit basis for the coming year from the following information of a
manufacturing company. Expected annual sales is 156000 units of 10 per unit. The anticipated ratio of cost to
selling price are: Raw materials 50% and Direct wages 15%. Budgeted cash overhead is 42,000 and depreciation
is ₹10,000 per annum. Planned stock will include raw material for 45,000 and 9,000 units of finished goods.
Credit allowed to debtors is 1 month. Credit expected to be received from suppliers in 3 weeks. Overhead and
wages payment will be made 1 week after their occurrence. Material will stay in the process for 14 days. Cash in
hand to be maintained is 15% of total working capital. Assume that production is carried on evenly throughout the
year. Raw materials are introduced at the beginning of the process and wages and overhead accrue evenly during
processing. or (a) Between two periods of a company there is an increase of debt collection period and raw
materials conversion period by 20 days and 5 days respectively, whereas its creditors payment period and finished
goods conversion period is reduced by 10 days and 5 days respectively. Calculate the change in operating cycle of
the company. (b) Length of Operating Cycle is the major determinant of the working capital needs of a business
firm. – Explain.
8. (a) How the trade-off between Matching and Conservative Policy of financing the working capital is done?
Explain. (b) Explain the three principal motives for holding cash.
9. A company is considering two mutually exclusive projects X and Y. Following details are made available to you:
(₹in lakh)
Project X Project Y
Project cost 3500 3500
Cash Inflows:
Year 1 500 2500
Year 2 1000 2000
Year 3 1500 1000
Year 4 2250 500
Year 5 3000 500
Assume no residual values at the end of the fifth year. The firm's cost of capital is 10%.
You are required to calculate the following in respect of the two projects –
(a) Net Present Value, using 10% discounting;
(b) Internal Rate of Return;
(c) Profitability Index.
Present value of 1 at 10% discount rate for y1-.909, y2-.826, у3-.751, у4-.683, у5-.621. or what is capital
rationing? How is it applied in case of divisible and indivisible projects?
10. The following details of P Ltd. for the year ended 31.3.2016 are furnished:
Operating leverage 3:1
Financial leverage 2:1
Interest charges per annum 20 lakhs
Corporate tax rate 50%
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Variable cost as the percentage of sales 60%
Prepare the Income statement of the company.
Or, critically examine the net income (NI) approach of capital structure theory.
11. (a) Z Ltd. issued 10,000 12% preference shares of 100 each at a premium of 10%. The floatation cost was 5%
on issue price. The preference shares will be redeemed at a premium of 20% after five years. The tax rate
applicable to the company is 30%. The corporate dividend tax is 10%. Compute cost of preference shares of Z
Ltd.
(b) T Ltd. has the following capital structure:
(₹ in lakhs)
Equity Shares Capital (10 lakh shares) 100
Retained Earnings 130
14% Debentures (70,000 debentures) 70
16% Term Loan 100
12. The market price per equity share is 25. The next expected dividend per share is 2 and is expected to grow at
8%. The debentures are redeemable after six years at par and the current market quotation is ₹90 per debenture.
The tax rate applicable to the firm is 50%. You are required to compute weighted average cost of capital of the
company using market value as weights.
Or
(a) What are the factors to be considered for paying cash dividend
(b) Give a brief note on Gordan’s Dividend policy?
B. Com (Hons.) 2018
1. Discuss the three broad areas of financial decision making.
2. Do you think that the profit maximization goal is an operationally feasible criterion? Critically explain your view.
or, Comment on the emerging role of the chief financial manager in ness environment.
3. A fixed deposit receipt has a maturity value of ₹1,33,100. What is the amount at which the fixed deposit has been
initially purchased if compound interest rate is 10% p.a. and the maturity period is 3 years? or, Explain the risk
return relationship in the context of modern business environment.
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4. Mr. Sen estimates that he needs to withdraw Rs. 2,40,000 every year from his bank for the next three years. He
wants to know the amount of deposit he should have in his bank today to meet the above requirement if the rate of
interest is 4% p.a. (Given PVAF (4%, 3) = 2.775). or, Mr. X retires at the age of 60 and his employer gives him two
options: Option one is a lump sum of 12,00,000 on retirement, and Option two is to accept a pension of 1.50.000 per
year for rest of his life. It is expected that he will survive for another 15 years. If the rate of interest is 9% p.a. and
PVFA9%.15=8.061. Advice Mr. X about his best alternative.
5. S. Ltd. is planning its capital investment programme for next year. It has 4 proposals all of which gives a positive
NPV at the company cut off rate of 12%. The required initial capital outlay and present values are as follows:
Proposals Initial
Capital NVP Profitability
Outlay (₹) (@12%) Index
X1 2,25,000 67,500 1.30
X2 1,00,000 45,000 1.45
X3 1,50,000 60,000 1.40
X4 1,75,000 64.750 1.37
The company is limited to a capital spending of Rs. 3,00,000.
Which proposals the company should accept? Assume that the proposals are indivisible and there is no alternative
use of the money allocated for capital budgeting.
6. L. Ltd. provides you the following information:
(a) Purchase price of machine ₹1,73,500

(b) Useful life of machine 3 years
(c) Salvage value at the end of useful life NIL
(d) Cost of Capital 10%
(e) Cash Flow after Tax (CFAT)
Year- 1 1,00,000
Year- 2 1,00,000
Year- 3 80,000
Note: Present Value factors @ 10% are as follows:
Year: 1 2 3
PV Factor: 0.909 0.826 0.751
Calculate the Discounted Payback Period.
7. From the following information presented by a manufacturing company, estimate the working capital
requirement for the coming year.
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GOBIND KUMAR JHA
The monthly sales volume is expected to be 40,000 units at ₹20 per unit. The anticipated ratios of different
elements of cost to selling price are: Raw material - 50%, Labour - 25%. It is estimated that budgeted overhead per
week will be ₹20,000 including depreciation of 5,000. Planned stock will include raw material for ₹1,50,000 and
finished stock 20,000 units. Credit period allowed to debtors is 3 weeks. Credit period expected to be received from
suppliers is 2 weeks. Overhead payment will be made 1 week after incurring expenses. Wages will be paid at the
beginning of the week following the week of the work. The average processing period of each unit will be 7 days.
Cash in hand to be maintained for contingencies is ₹20,000. Arrangement of bank overdraft to the extent of
₹1.00,000 has been made. Assume that production is carried on evenly through out the year and overheads accrue
similarly.
or,
(a) The following information is provided by X Ltd. for the year ending 31.3.2017.
Raw Material storage period 45 days

WIP conversion Period 18 days
Finished Goods storage period 22 days
Debt collection period 30 days
Creditors payment period 55 days
Annual cash cost of operation 18 Lakhs
(1 year = 360 days)
You are required to calculate:
(i) Operating Cycle Period.
(ii) Number of Operating Cycles in a year.
(b) Why are both gross concept of working capital and net concept of working capital useful for working capital
management?
8.(a) Do you recommend that a firm should finance its current assets entirely with short-term financing? Explain.
(b) Discuss various bank lending norms as recommended by Tandon Committee for financing of working capital
requirement of business.
9. A company is exploring the proposal of replacing its existing machine which is unable to meet the production
schedule to match the rapidly rising demand of its product. The company has two options: either to overhaul the
existing machine at a cost of 230 lakh or to go in for a New Machine with higher capacity at cost of 248 lakh. Both
the machines are expected to be operational for 5 years.
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Cash Inflows (in Lakh)
Year
Overhauled Mahine New Machine
1st Year 5 12
2nd Year 6 16
3rd Year 24 20
4th Year 16 20
5th Year 14 18
Total 65 86
The cost of capital to be considered is 10%.
You are required to appraise the two alternatives with the help of (a) Net Present Value Method and (b) Discounted
Pay Back Period Method. Present value of- I at 10% discount rate are as follows:
Year 1 2 3 4
P.V. 0.91 0.83 0.75 0.68
10. Calculate different kinds of leverage from the following information of XYZ Company:
Production and sales 1600 units

Selling price per unit ₹30
Variable cost per unit ₹20
Fixed operating costs:
Situation A ₹4,000
Situation B ₹2,000
Situation C ₹6,000
Financial alternative: Plan

____________________________
I II III
Equity ₹15,000 ₹10,000 ₹5,000
Debt carrying 10% interest ₹5,000 ₹10,000 ₹15,000
How are the information relating to leverage useful in financing decisions?
or,
What do you mean by optimum capital structure? What factors would you consider in planning capital structure of
your company?
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GOBIND KUMAR JHA
11.(a) What do you mean by explicit cost of capital and implicit cost of capital?
(b) X Ltd. opts for the following capital structure:

₹
Equity Shares (1,00,000 shares of 10 each) 10,00,000
10% debentures 15,00,000
_____________
25,00,000
_____________
The company is expected to declare a dividend of ₹2 per share.
The market price per share is ₹20. The dividend is expected to grow at 10%. Compute the weighted average cost of
capital assuming 50% tax rate.
12. The earning per share of a company is ₹8 and the rate of capitalization applicable is 10%. The company has
before it, an option of adopting (a) 50%, (b) 75%, and (c) 100% dividend payout ratio.
Compute the market price of the company's quoted share as per Gordon's Model if the company can earn a return
of (a) 15% (b) 10% and (c) 5%.
or,
Critically discuss Walter's dividend model. To what extent are the shortcomings of this model taken care of by
Gordon's dividend model?
B. Com (Hons.) 2019
1. Elucidate the interrelationship between financing decision, investment decision dividend decision.
2. What do you mean by value maximisation objective of a firm? How does it differ from profit maximization
objective? or, how does a chief financial executive, as a member of top management, discharge his role in the
formulation of policies and decision making?
3. Mr. X needs 1,00,000 at the end of 10 years. He has two options:
Option 1: Deposit some lump sum amount today at 6% rate of interest.
Option 2: Make equal payments into a bank account starting a year from now, on which he earns 6% rate of
interest.
You are required to:
(a) Find out the amount to be deposited under Option 1 today.
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(b) Ascertain what amount must be deposited annually into the bank account under Option 2. CVIF ( 6%,10)=1.791,
CVIFA(6%,1) = 13.181, PVIFA(6%,10) 7.360, PVIF(6%,10)= 0.558.
4. Mrs. L intends to take a loan of 10,00,000 from a bank repayable by an equal annual instalment over a period of
five year? The bank charges interest @10% p.a. on such loan. How much is she required to pay in each instalment?
5. Payback period method of project evaluation is considered conceptually unsound. Do you agree with this view?
Critically discuss. or, which one of the following two projects should be selected based on discounted payback
method of appraisal while both involve capital outlay of 10 crore and likely to generate same amount of cash flow
over their lives.
Year Cash flow stream (₹ in lakh)

A B
1 200 500
2 300 400
3 400 300
4 500 200
Cost of capital of the firm: 10%
P.V. of ₹1 at 10% to be received at the end of each year is as below.

Year 1 2 3 4
PV Factor 0.91 0.83 0.75 0.68
6. X Ltd. provides the following information:
(a) Annual cost saving 96,000

(b) Useful life 5 years
(c) Salvage value ₹0
(d) Internal Rate of Return 15%
(e) Profitability Index (PI) 1.05
You are required to calculate:
(i) Cost of the project (ii) NPV of the project
PVIFA (15%) 3.353
Or, What is Accounting Rate of Return (ARR) method in the context of capital expenditure decision?
7. From the following information presented by a manufacturing company, prepare statement showing working
capital requirement for 2019-2020:
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GOBIND KUMAR JHA
Expected monthly sales of 1,00,000 units at 15 per unit. The anticipated ratios of raw- material cost and wages of
selling price are:
Raw-material cost - 40%
Wages -30%
Budgeted overhead is worked out at 50,000 per week. Overhead expenses include depreciation of 20,000 per week.
Planned stock will include raw-material of 1,20,000 and 40,000 units of finished stock.
Material will stay in process for 2 weeks. Credit period allowed to debtors is 5 weeks.
Credit period allowed by creditors is 1 month. Lag in payment of wages and overhead is 2 weeks.
20% of sales may be assumed to be made against cash, and cash in hand is expected to be₹50,000.
Assume that production is carried on evenly throughout the year and wages and overhead accrue evenly.
8. (a) What do you mean by aggressive and conservative current asset financing policies? State your preference
with reasons.
(b) Write a short note on the recommendation of Chore Committee.
9. A company will purchase either Machine X or Machine Y. Following are the information regarding the two. The
estimated life of both the machine is five years with no salvage value.
Cost (₹) Anticipated cash flows after tax per year (₹)
Yr.1 Yr.2 Yr.3 Yr.4 Yr.5
Machine X 17,18,750 1,50,000 1,80,000 13,75,000 9,62,000 4,12,000
Machine Y 27,50,000 6,78,500 9,62,500 11,00,000 11,68,750 5,50,000
The company's cost of capital is 10\% You are required to advise the management as to which one should be
procured using both (1) NPV and (ii) IRR method of project appraisal.
Year 10% 12% 14%

1 .909 .893 .877
2 .826 .797 .769
3 .751 .712 .675
4 .683 .636 .592
5 .621 .567 .519
or,
(a) What is Modified Internal Rate of Return (MIRR) in the context of Capital Expenditure Decision of a firm?
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(b) What do you understand by Reinvestment Rate and what are its assumptions under the Net Present Value and
Internal Rate of Return method.
10. The selected financial data for two companies namely X and Y for the year ended March 2019 are as follows:
Particulars X Y
Variable expenses as a percentage of sales 75 50
Interest (in lakhs) 3600 1000
Degree of operating leverage 6 2
Degree of financial leverage 4 2
Income tax rate 0.35 0.35
(a) Prepare income statements for X and Y.
(b) Comment on the financial position of the companies.
or, (a) "Neither over-capitalisation nor under-capitalisation is desirable". Justify the statement.
(b) Critically examine the Net Income (NI) Approach to capital structure.
11. A company has following amounts of capital with corresponding specific cost of each type:
Type of capital Book value Market value

(Rs) (Rs)
Equity capital (25,000 shares of Rs 10 each) 2,50,000 4,50,000
13% Preference capital (500 shares of Rs100 each) 50,000 45,000
Reserves and Surplus 1,50,000 -
14% Debentures (1,500 Debentures of Rs100 each) 1,50,000 1,45,000
The expected dividend per share is 1.40 and the dividend per share is expected to grow at a rate of 8% forever.
Preference shares are redeemable after 5 years at par, whereas debentures are redeemable after 6 years at par. The
tax rate for the company is 50 per cent.
You are required to compute weighted average cost of capital using market value as weight.
12. (a) Explain the term 'Dividend' and 'Dividend Policy'.
(b) Determine the market price of equity shares of company from the following information using Walter Model:
Earnings of Company ₹5,00,000

Dividend paid ₹3,00,000
Number of Shares 1,00,000
Price earning ratio 8
Rate of Return on Investment 15%
Are you satisfied with the dividend policy of the firm? If not, what should be the optimal dividend payout ratio and
the consequent market price of equity shares of the company according to Walter Model?
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GOBIND KUMAR JHA
B. Com (Hons.) 2020
1. You are working in a firm having ROI 18% and Cost of Capital 12%. For a proposed project with effective life of
3 years the inflows are estimated as 67,500,76,500 and 56,700. Calculate the present value of benefits from the
project.
2. Discuss Matching and aggressive approaches in the context of Working Capital.
3. Y Ltd. Started a project with the initial investment of ₹5,00,000. The life of the project is 5 years. It is expected
that cash inflows starting from first year to fifth year will be 1,10,000,1,40,000, ₹1,80,000, ₹2,50.000 and ₹
3.80.000 respectively. What will be the Pay back period of the project?
4. From the following information. Determine the theoretical market price of each equity share of a company as per
Walter’s Model:
Earnings of the Company ₹10,00,000

Dividend paid ₹5,00,000
No. Of equity shares outstanding 2,00,000
Cost of Equity Capital 12%
Rate of return on investment 15%
5. Calculate weighted average cost of capital (WACC) considering market values for AD Ltd. From the following
details:
Sources of Capital
Equity share capital (₹10 each) ₹12,00,000
Retained Earnings ₹28,00,000
14% Preference shares (issued at a premium of 8%) ₹90,000
15% Debentures ₹3,60,000
Other information:
• Applicable corporate tax rate 30%

• Market price per share ₹50 Dividend per share is expected to be 6. AD Ltd. Maintains a growth of 5% in this
regard.
• Debentures of face value ₹1000 each were issued at 3% discount (with an additional underwriter, commission of
1.5% on face value). Tenure of Debenture 10 years.
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6. PP Construction Ltd. Is considering the five possible projects to invest in, as shown below:
Project Cash Outflow (₹) PV of Cash Inflows(₹)

A 5,00,000 7,50,000
B 2,00,000 2,10,000
C 5,00,000 8,00,000
D 1,00,000 80,000
E 3,00,000 3,30,000
Available fund is 12,00,000. Apply capital rationing decision concept and select the projects. All the projects are
divisible in nature.
7. Relevant information about two companies are given below:

X Y
Annual production capacity (Units) 1,00,000 1,50,000
Capacity Utilisation and sales 75% 75%
Unit selling price () 40 50
Unit variable cost() 15 15
Fixed cost for the year () 2,00,000 3,00,000
Equity capital (10 per share) 5,00,000 7,00,000
10% Preference share capital () 1,00,000 50,000
15% Debentures (2) 2,00,000
Determine the degree of Operating Leverage, degree of Financial Leverage, degree of Combined Leverage and
Earning per Share of two companies (Tax rate 40%).
8. The capacity of your company is to produce 40,000 units of valve per annum. The company expects to operate at
60% of the capacity level. You are required to ascertain the working capital requirement at the current level of
operation.
The following information on the cost-price structure of valves at the current level of production is available:
Elements of cost Per unit(₹)

Raw-materials 6
Direct labour 3
Overhead 4
Total cost 13
Profit 3
Selling price 16
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GOBIND KUMAR JHA
Gobind Kumar Jha
9874411552
Raw-materials are in stock, on an average, for 2 months. The duration of the production process is half a month.
Finished goods are in stock, on an average for 1 month. Credit allowed to customers is 3 months and that obtained
from suppliers is 1.5 months, lag in payment of wages is half a month. There is usually on lag in payment of
overhead.
9. X Ltd. Wants to purchase one machine out of two mutually exclusive machines under consideration. Other
information related to these machines are as below:
Particulars Machine 1 Machine 2

Purchase price (₹) 3,00,000 2,80,000
Estimated Life (Years) 5 5
Net cash flows (₹)
Year 1 80,000 60,000
Year 2 1,20,000 80,000
Year 3 90,000 1,20,000
Year 4 85,000 1,50,000
Year 5 1,58,000 92,000
Compute the NPV of each machine assuming a cost of capital of 10%, Which machine should the company buy?
The present value of ₹1 to be received at the end of each year at 10% is given below:
Year 1 2 3 4 5
P.V (₹) 0.909 0.826 0.751 0.683 0.621
10. (a) Mention any five important factors that a firm should consider in formulating dividend policy.
(b) Discuss financial leverage with reference to the formulae.
B. Com (Hons.) 2021
1. Discuss the important functions of financial management.
2. What do you mean by wealth maximization objective of a firm? How can it be achieved by the firm? Why is it
considered superior to the profit maximization objective of the firm?
3.(a). What do you mean by time value of money? What are its reasons?
(b). X decides to invest 26,000 at the beginning of each year at the compound rate of interest of 12% p.a. for 8
years. What total amount he will get at the end of the year? [FVAF at 12% for 8 years 12.30]
4(a). Calculate payback period from the following information:
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Cost of machine: 1,00,000; Depreciation 10% p.a. under reducing balance method.
Corporate tax rate 40%.
Year 1 2 3 4 5
Expected NIL 54 88 104 125
PBT (₹ .000)
(b). What are the distinguishing features of capital budgeting decisions?
5. A firm is considering the proposal of buying a machine with installation cost of 5,00,000. The machine will have
a useful life of 4 years after which it can be sold for 70,000. Depreciation is to be charged under straight line
method. Additional working capital of 50,000 will be introduced. Profits before depreciation and tax are expected
to be ₹ 1,72,000, ₹ 1,98,000, ₹2,18,000 and 1,80,000 in those four years. If applicable tax rate is 30%, calculate
ARR of the project.
6. Discuss the various sources of finance to meet working capital requirement.
7. A firm has sales of 10,00,000, variable cost of ₹7,00,000 and fixed cost of 2,00,000. The company has debt
capital of 3,00,000 at 10% rate of interest. Compute operating, financial and combined leverages. If the firm wants
to double its earnings before interest and tax (EBIT), how much rise in sales would be required?
8. You are given the following information in respect of ABC Ltd.
Earning ₹ 1,00,000
Equity capital 5,000 shares of ₹10 each
Cost of capital 10%
Expected rates of return (i) 9%, (ii) 10% and (iii) 12%
Assuming that dividend pay-out ratios are 0%, 50% and 100% respectively, determine the effects of the different
dividend policies on the share price of ABC Ltd. For the above mentioned three alternative levels of rate of return
using Gordons’s model.
9(a). Discuss the relevance of cost of capital. What do you mean by implicit and explicit cost of capital?
(b). A company’s share is currently quoted in the market at 230. The company paid a dividend of 25 per share last
year and the investors expect a growth rate of 5% per year.
You are required to calculate (i) cost of equity share capital of the company and (ii) the market price per share, if
the anticipated growth rate of dividend is 10%.
10.(a). What do you mean by EBIT-EPS Analysis? Discuss its importance in financing decision.
(b). Discuss the significance of operating leverage and financial leverage.
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GOBIND KUMAR JHA
11. Following details are available from the management of BAS Ltd.
Particulars Amount per Unit (₹)

Raw materials 120
Direct labour 45
Overhead 90
The company wants to make 15% profit on sales price.
The following further particulars are available
Raw materials are kept in stock, on average, for one month, Processing time can be taken as, on average, half a
month, Finished goods in stock, on average, for 30 days. Credit enjoyed by BAS Ltd. Is one month, Credit allowed
is for two months, Average time-lag in payment of wages and overhead is one month. Cash in hand and at bank is
desired to be maintained at 30,000 BAS Ltd prefers to value debtors at sales value.
Compute the working capital required for BAS Ltd. With necessary assumptions to finance level of activity of
24,000 units of production in the next year.
12.(a). SMB Ltd. Has considered two projects with economic life of 6 years having following cash inflows after
tax:
End of year 1 2 3 4 5 6 Total (₹)

Project1 1,00,000 80,000 75,000 70,000 68,000 62,000 4,55,000
Project2 62,000 68,000 70,000 75,000 80,000 1,00,000 4,55,000
As the total cash inflows are identical and investment amount is 3,30,000 for both the projects, the management of
SMB has decided to go for any one of the given projects. Do you support their decision? Justify your answer.
The post-tax cost of capital of SMB Ltd. Is calculated as 10%, and the required discounting factors are given
below:
Year 1 2 3 4 5 6
DF@10% 0.909 0.826 0.751 0.683 0.621 0.564
(b). Project A and Project B are the two mutually exclusive projects under consideration. While Project A has a
higher NPV, Project B has a higher IRR. Which Project should be selected and why?
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B. Com (Hons.) 2022
1. Explain the inter-relationship between financing decision, investment decision and dividend decision.
Or, Discuss the significance of wealth maximisation.
2. Ms. B is considering two investment proposals for an amount of ₹5,000 with following details:
Return from Investment (₹)

Proposal Maturity Period Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
D 5 years 600 600 600 600 600 N.A.
G 6 years NIL NIL NIL NIL NIL 800
PV for Re. 1 at 10% 0.9 0.8 0.7 0.6 0.6 0.5
09 26 51 83 21 64
Or, Suggest her for selecting the better option considering 10% discounting rate.
3. Briefly discuss the different strategies of financing current assets with graphical presentation.
Or, What are the various sources of finance to meet working capital requirement?
Q.4. Briefly explain how the risk-return trade off play a significant role in the financial decision making.
Or, Explain the significance of time value of money in financial decision making. Calculate present value of a
5year annuity of 20,000 at a discount rate 10%.
5. Cost of plant ₹12.25 crore. Economic life of the plant is 6 years. Salvage value is estimated as 25lakh. Pre-tax
Profit before depreciation is expected to be 3.4 crore for the first year. Find out the cash inflow from the plant
considering 30% corporate tax rate. Straight line method of depreciation is accepted.
Or, Define independent projects and mutually exclusive projects. Briefly discuss their selection criteria based on
NPV.
Q.6. The initial outlay for a project of economic life 6 years is 72,000. The cash flow after tax from this project for
the first year is 19,500 and it increased steadily by 6,000 per annum. Calculate payback period.
Q.7. Explain the concept of cost of capital. What do you mean by marginal cost of capital? Why should we
consider marginal cost of capital rather than weighted average cost of capital while evaluating a new project
Or. The existing capital structure of X Ltd. Is as follows:

Equity Share Capital and retained earning (Ke=17%) ₹5,00,000
14% Preference Share Capital ₹2,00,000
10% Debt ₹3,00,000
The company wishes to implement the expansion of the plant with capital outlay of 5,00,000. Besides using the
available retained earning of ₹ 1,00,000, the balance additional fund will be raised as follows:
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GOBIND KUMAR JHA
10% Debt ₹3,00,000
14% Preference Share Capital ₹1,00,000
Corporate tax rate is 20%.
Assuming that specific cost of different components of capital remaining same, you are required to
(a)Calculate weighted average cost of capital after the issue of fresh securities;
(b)Calculate the marginal cost of capital, and
(c)Comment on the acceptance of the expansion plan if it is expected to give a return of 12%.
Q.8. From the following information presented by a manufacturing company, prepare a statement showing working
capital requirement for the coming year.
Expected monthly sales of 64,000 units at 20 per unit. The anticipated ratios of
Selling price are:
Raw-materials-40%
30% Labour
Budgeted overhead 32,000 per week.
Overhead expenses include depreciation of 8,000 per week. Planned stock will include raw-materials for 1,92,000
and 32,000 units of finished goods.
Material will stay in process 2 weeks Credit allowed to debtors is 4 weeks Credit allowed by creditors 5 weeks.
20% of sales may be assumed to be made against cash. Cash and Bank is to be maintained at 10% of the working
capital.
Assume that production is carried on evenly throughout the year and wages and overhead accrue similarly.
Or, What do you understand by working capital cycle? State the factors on which the duration of working capital
cycle depends. Explain the significance of working capital cycle in working capital management.
9. The selected financial data fur companies A and B for the current year ended March 31, 2022 are as follows:
Particulars Company A Company B

Variable cost as a percentage of Sales 60 75
Interest (₹) 500 800
Degree of Operating Leverage 4 5
Degree of Financial Leverage 2 3
Income tax rate 0.30 0.30
(a)Prepare income statement of Company A and Company B.
(b) Comment on the risks of the two firms.
Or, (a) What do you mean by optimum capital structure? What are its features?
(b) Explain the net income approach to the capital structure theory.
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10. B. Bakshi Co is evaluating two independent and indivisible projects SB and AKB with following details:
Post tax cash inflows (₹)

Project Investment (₹) Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
SB 1,50,000 36,800 38,700 44,700 50,100 41,500 55,000
AKB 74,800 15,900 28,200 30,500 32,100 37,800 NIL
(a)Comment on the selection of the project on the basis of net present value considering 8% discounting rate
Year 1 2 3 4 5 6
PV for Re. 1 at 8% 0.926 0.857 0.794 0.735 0.681 0.630
(b)Review your decision under profitability index approach and comment.
Or, (a) Discuss the demerits of payback period approach.
(a) Discuss the effect of income tax, salvage value of assets and depreciation on cash inflows of a project under
consideration.
11. P. Mitter Ltd. Is having cost of capital 10 per cent and return on investment 12 per cent. The company earned 20
as profit per share and declared 30% dividend.
(a) Calculate the market price of equity share under Walter’s model.
(b) To increase the market price per share, the management is willing to increase the dividend pay-out ratio in the
next financial year, but the CFO Mr. Tapesh has opposed such a decision. Give your opinion in this matter.
Or, (a) Discuss the pros and cons of scrip dividend.
(b) Differentiate between constant dividend rate policy and constant dividend payout policy with diagram.
B. Com (General) 2017
1.(a) State two functions of financial management.
Or,
What is “investment decision’?
(b) Write two functions of the Chief Financial Officer.
(c) Define marginal cost of capital.
(d) What is ‘bonus share”?
Or,
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Name any two sources of long-term finance.
(e)What is working capital management?
(f)What is permanent working capital?
Or,
What do you mean by temporary working capital?
(g)What is Accounting Rate of Return’?
Or,
What is ‘Discounted Cash Flow?
(h)State whether following statements are true or false:
(i)Depreciation on fixed assets is an out-of-pocket cost.
(ii) Payback period method does not consider time value of money.
(i)Define Final Dividend’.
(j)State two assumptions of Walter’s Model.
Or,
What is dividend-irrelevance theory?
2. Do you think that wealth maximisation is a better goal of a firm than profit maximisation? Why?
3. From the information given below, estimate the working capital requirement of the firm:
(a) Project annual sale 26,000 units
(b) Selling price per unit - ₹60
(c) Analysis of selling price –
Material 40%, Labour 30%, Overhead 20%, Profit-10%
(d)Time Lag-
Raw Materials in stock – 3 weeks
Production process – 4 weeks
Credit to debtors – 5 weeks
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Credit from suppliers – 3 weeks
Lag in Payment of wages and overhead – 2 weeks
Finished goods are in warehouse – 2 weeks
(e)Cash in hand expected to be 10% of net-working capital.
Or,
Explain the concepts of ‘Net-Working Capital’ and ‘Working Capital Cycle’ in brief.
4. What do you mean by specific cost of capital? Why do we use weighted average cast of capital?
5. From the following information relating to A Ltd., determine the market price of shares sing Gorden’s Model:
Total investment in assets ₹10,00,000

No. Of shares 50,000
Total earnings ₹2,00,000
Cost of capital 16%
Pay-out ratio 40%
Or,
Explain in brief the types of dividend policies.
6. What is capital budgeting? Write brief notes on any two types of project.
Or, Compute the pay-back period for the project from the following information
Cost of Asset-₹100
Depreciation-15% under straight line method
Profit after tax for the five years-
Year 1- ₹15, Year 2- ₹20, Year 3- ₹25, Year 4- ₹30 Year 5 - ₹35
7.(a) Define financial market.
(b) How would you explain the risk-return relationship?
Or,
7.(a) The present value of certain sum of money is more valuable than the future value of the same amount. Explain
with reasons.
(b) Dr. Kanjilal is given the following two options by his employer at the time of his retirement:
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Option I- An annual pension of ₹50,000 as long as he lives
Option II-A lump sum payment of ₹3,00,000
If he expects to live for 15 years and his time preference for money is 12%, which option should he choose.
[Given PVIF12.15= 6.811]
8. X Ltd. Is presently considering two machines for purchase. Information related to the machines are given below:
Machine 1 Machine 2
Purchase Price ₹50,000 ₹60,000
Estimated life 4 years 4 years
Method of depreciation St. Line St. Line
Estimated scrap value Nil Nil
Cash Flow before depreciation and tax:
Year 1 ₹25,000 ₹45,000
Year 2 ₹25,000 ₹19,000
Year 3 ₹25,000 ₹25,000
Year 4 ₹25,000 ₹27,000
Rate of tax is 50%
Compute net present value of cash flows for each machine assuming cost of capital 10%. Which machine the
company should buy?
The Present value of Re. 1 at 10% is as follows:
Y1 – 0.909, Y2 – 0.826, Y3 – 0.751, Y4 – 0.683
9. Discuss the five recommendations of Chore Committee in regard to bank lending for working capital finance.
Or, Discuss any two strategies of financing current assets.
10. Calculate different types of Leverage and EPS of ABC Ltd from the following information:
Equity Share Capital

(12,000 shares @ ₹10 each) ₹1,20,000
Retained Earnings ₹40,000
Turn Over ₹12,00,000
Fixed operating cost ₹10,000
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Variable operating cost ratio 40%
Income tax rate 40%
Or,
What is Optimum Capital Structure? What are it’s features?
1.(a) What do you mean by ‘time value of money’?
(b) What is ‘annuity’?
Or, Name two principal components of financial environment.
(c)What is trade credit”?
Or, What is ‘public deposit’?
(d)What is ‘convertible debenture”?
Or, What is ‘weighted average cost of capital’?
(e)State two assumptions of ‘Net Income Approach’ of capital structure theory.
(f)What is ‘trading on equity’?
(g)What do you mean by ‘aggressive working capital policy’?
Or, Name two important committees set up for the management of working capital requirement.
(h)What is ‘ABC Analysis’ of inventory management?
2. Mr. Y has two options:

Option A: Receive Rs. 40,000 two years from now
Option B: Receive Rs. 60,000 seven years from now
(a)Which one should Mr. Y choose if the discount rate is 11%?
(b) What option should be choose if the discount rate is 6%? Comment on the results obtained in (a) and (b) above.
Given PVIF11%,2= 0.812, PVIF11%,7 =0.482, PVIF6%,2 = 0.890, PVIF6%,7 = 0.665.
3. Write short notes on any two:

(a) Ploughing back of profit
(b) Lease financing
(c) Cumulative and non-cumulative preference share .
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Or, 3(a) A company’s share is currently quoted in the market at Rs. 20. The company pays a dividend of Rs. 2 per
share and the investors expect a growth rate of 5% per year. Calculate: (i) cost of equity capital of the company and
(ii) the market price per share if the anticipated growth rate of dividend is 7%.
(b) Find out the cost of retained earnings from the following information: Cost of equity capital = 10%, brokerage
cost = 2% and tax rate = 50%.
4. From the following information calculate Degree of Operating Leverage (DOL) Degree of Financial Leverage
(DFL) and Degree of Combined Leverage (DCL):
(a) Sales ₹9,60,000
(b) Variable Cost ₹5,60,000
(c) Fixed Cost ₹2,40,000
(d) Interest ₹60,000
5. State the objectives of Inventory Management.
6. Briefly explain the concept of ‘Economic Order Quantity’.
7.(a) Distinguish between profit maximisation and wealth maximisation objectives of a firm.
(b)Which one of these two objectives should be pursued by a firm?
(c)Explain in brief three major decision-making functions of financial management.
Or,7(a) Define Financial Management.
(b) Discuss the role of Chief Financial Officer.
8.(a) What is negative working capital?
(b) What do you mean by working capital cycle?
(c) What factors are to be considered in determining the working capital need of a firm?
Or, From the following information of X Ltd., determine the working capital requirement:
(a) Expected annual sales: ₹3,60,000
(b) Analysis of selling price:
Raw materials: 50%

Expenses: 30%
Profit: 20%
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(c) Raw materials in store: 1 month
(d) Processing period: 2 months
(e) Finished goods in store: 4 months
(f) Credit allowed to debtors: 2.5 months
(g) Credit allowed by creditors: 1.5 months
(h) Production is carried out evenly during the year and expenses accrue similarly.
9. (a) State two limitations of Payback Period (PBP) method.
(b) X provides you the following information:

(i)Purchase price of machine ₹5,00,000
(ii) Estimated salvage value at the end of useful life ₹1,00,000
(iii) Useful life 5 years
(iv) Expected annual profits, including depreciation and taxes, for the next 5 years from the project are ₹75,000,
₹1,75,000, ₹2,00,000, ₹2,00,000 and ₹50,000 respectively.
(v) Tax rate 50%
(vi) Depreciation is charged under the straight line method. Calculate the Accounting Rate of Return (ARR) of the
capital investment.
(c)Mention any two objectives of capital expenditure decisions.
10. (a) What is Capital Rationing’?
(b) A Ltd. Is considering an investment proposal which will require an initial investment 2,80,000 in fixed facilities
and an additional 40,000 as working capital. The project expected to generate cash flows of 1,20,000, ₹ 1,00,000,
₹85,000, ₹95,000 and 10.000 respectively before tax over its 5year lifetime. The estimated scrap value of the
project is 25,000). The applicable tax rate is 40% and the cost of capital is 10% p.a. Calculate Net Present Value
(NPV) of the project and advise on its acceptability.
Year Cash Inflow Deprn. PAD Tax@40% (PAT+Deprn.)*PVF PV

1. 1,20,000 51,000 69,000 27,000 (41,400+51,000)*0.91 84,084
2. 1,00,000 51,000 49,000 19,600 (29,400+51,000)*0.83 66,732
3. 85,000 51,000 34,000 13,600 (20,400+51,000)*0.75 53,550
4. 95,000 51,000 44,000 17,000 (26,000+51,000)*0.63 52,632
5. 90,000 51,000 39,000 15,600 (23,400+51,000)*0.62 46,128
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3,03,126
Add: Working Capital released at the end of year 5 (40,000 x 0.62) 24,800
Add: Scrap sold at the end of year 5 (25,000 x 0.62) 15,500
Less Initial Investment and working capital (2,80,000+40,000)
Comment:
A Ltd. May accept the investment proposal on the basis of (+) ve NPV.
Or, (a) State two similarities and two dissimilarities between Net Present Value (NPV) method and Internal Rate of
Return (IRR) method.
(b) Write a note on ‘Profitability Index (PI)’ method of project evaluation.
11. (a) What is ‘Interim Dividend’?
(b) From the following information calculate the market price of the share using Walter’s model:
Earnings Per Share (EPS) = Rs. 6, Internal Rate of Return (IRR) = 20%, Cost of Capital = 10%, Dividend Payout
Ratio (D.P. Ratio) = 80%. Is it the optimum payout ratio? Justify your answer.
1.(a) Choose the correct answer:

Long-term investment decisions of a firm are concerned with
(i)working capital management (ii) capital structure (iii) capital budgeting (iv) dividend.
(b) State two defects of profit maximization objective of a firm.
Or, Define ‘Financial Management’?
(c)What is operating lease’?
Or, What is ‘commercial paper”?
(d)What is ‘term loan’?
Or, What is ‘explicit cost of capital”?
(e) State two assumptions of Net Operating Income Approach of capital structure theory.
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(f) What is ‘capital structure’ of a firm?
(g) What do you mean by conservative working capital policy?
(h) Mention any two sources of working capital finance from bank.
Or, Write down the formula for computing Inventory turnover ratio.
2.State four advantages of ‘value maximization’ objective of the firm. Who is a ‘Chief Financial Officer’?
3. (a) Advantages of ‘preference share’.
(b) Features of institutional financing.
Or,
A company has the following capital structure and after-tax costs for the different sources of funds:
Sources of Funds Amount (₹) (Book Value) After-tax costs (%)

Equity Share Capital 50,000 15
(paid-up)
Retained Earnings 10,000 15
Preferences Share 25,000 10
Capital
Debentures 15,000 8
Calculate the weighted average cost of capital using book value as weights.
4.A firm has sales of ₹ 5,00,000, variable cost of ₹3,50,000 and fixed cost of 1,00,000 Ans. Se and a debt of ₹
2,50,000 at 10% rate of interest. Compute the degree of combined leverage (DCL). If the firm wants to double its
EBIT, how much of a rise in sales would be needed on a percentage basis?
5. Write short notes on:
(a) ABC Analysis
(b) JIT
Or, Briefly discuss the recommendations of the Chore Committee regarding bank financing.
6. (a) Mr. A. K. Sen deposits 6,000, ₹ 8,000, ₹ 12,000, ₹ 14,000 and ₹10,000 at the beginning of 1st, 2nd, 3rd, 4th and
5th year respectively. The deposit earns a compound interest of 12% p.a. Calculate the future value of the deposit at
the end of 5th year.
Given FVIF12,2=1.254, FVIF12,3=1.405, FVIF 12,4=1.574, FVIF12,5=1.762.
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(b) If the nominal rate of interest is 12% p.a. and interest is paid four times in a year, what will be the effective rate
of interest?
(c)Explain the term ‘systematic risk’ with example.
Or, (a)Name four basic components of financial environment.
(b)Name the banking regulator and insurance regulator of India.
(c)Mr. Chatterjee is given the following two options by his employer at the time of his Retirement:
Option I: An annual pension of ₹ 72,000 as long as he lives.
Option II: A lump sum payment of ₹5,00,000.
If Mr. Chatterjee expects to live for 15 years and his time preference for money is 12%, which option should he
choose? Given PVIFA12,15 = 6.811.
7. From the following particulars, prepare a statement showing working capital requirement of a firm to finance a
level of activity of 5200 units of output per year:
Elements of Cost Amount per unit (₹)

Raw Materials 8
Direct Labour 2
Overheads 6
Profit 4
Selling Price 20
Raw materials are in stock, on an average, for one month. Materials are in process, on an average, for half a month.
Finished Goods are in stock, on an average, for six weeks. Credit allowed to debtors is two months.
Credit allowed by creditors is one month.
Lag in payment of wages is 1.5 weeks.
Cash in hand and at bank is expected to be ₹7,300. Production is carried on evenly during the year and wages
and overheads accrue similarly.
8. (a) State two drawbacks of Accounting Rate of Return (ARR) method.
(b) Mention three features of capital budgeting decision.
(c) A project requires an initial investment of 50,000. If the following amounts of cash inflows are taking place
from the project in different years, determine the payback period:
Year 1 2 3 4 5
Cash Inflows 20,000 16,000 12,000 8,000 14,000
(₹)
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9. (a) State three advantages of ‘Net Present Value’ (NPV) method.
(b) What is ‘Internal Rate of Return’?
(c)A project requires an initial outlay of 60,000 with a working life of 4 years. The annual cash inflows that will be
occurred from the project during the four years are expected to be 15,000, ₹ 24,000, ₹24,000 and 30,000
respectively. If the discount rate is 12%, calculate the Gross Profitability Index (GPI) and Net Profitability Index
(NPI) of the project.
PVIF 12,1 = 0.893, PVIF 12,2 = 0.797, PVIF 12,3 = 0.712, PVIF12,4= 0.636
Or, (a) Mention three disadvantages of ‘Internal Rate of Return (IRR) method.
(b) State three advantages of ‘Discounted Payback Period’ (DPBP) method.
(c) How will you take accept-reject decision under ‘Net Present Value’ (NPV) method and ‘Discounted Payback
Period’ (DPBP) method in the following cases:
(i) in case of single project

(ii) in case of mutually exclusive projects.
10. (a) From the following information, determine the market price of a share of X Ltd. Using Gordon’s Model:
Total investment in assets 10,00,000

Number of equity shares 50,000
Total earnings 2,00,000
Cost of capital 16%
Pay-out ratio 40%
(b) State the assumptions of Walter’s Model.
Or, (a) What is ‘dividend’?
(c) Explain the factors which influence the dividend policy of a firm.
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1. What are the functions of financial management?
2. Discuss the role of retained earnings as a source of corporate finance.
3. A company has issued debentures of ₹ 51 lakh to be repaid after 7 years. How much should the company invest
at the end of each year in a sinking fund earning 12%. To repay the debentures? (CVIFA 12% 6 = 10.089)
4. The current market price of an equity share of ₹10 each is 40. The current dividend per share is 6. If the dividend
is expected to grow at the rate of 5%, find out the cost of equity capital.
5. (a) What is Trading on equity?
b) Calculate the degree of operating leverage, degree of financial leverage and combined leverage from the
following data:
Sales 1,00.000 units @ ₹2 per unit = ₹2,00,000
Variable cost per unit @₹0.70
Fixed cost 1,00,000
Interest charges₹3,000
6. You are required to prepare a statement showing the working capital needed to finance a level of annual activity
of 52.000 units of output. The following information are available.
Elements of cost Amount per unit (I)

Raw materials 8
Direct Labour 2
Overhead 6
Selling price 20
Raw materials arc in stock, on an average for 4 weeks. Materials in process, on an average for 2 weeks. Finished
goods arc in stock, on an average for 6 weeks. Credit allowed to customers is for 8 weeks, credit allowed by
suppliers of goods is for 4 weeks. Lag in payment of wages is one and half weeks. It is necessary to hold cash in
hand or at bank amounting ₹80,000.
7. (a) What do you mean by working capital? Why is working capital necessary for a business?
(b) Write about the financial policy of current assets of a firm which follows conservative policy of maintaining
current assets.
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8. Details regarding three companies arc given below:
X Ltd. Y Ltd. Z Ltd.

Return of Investment (r) 15% 10% 8%
Cost of Capital (K) 10% 10% 10%
EPS ₹10 ₹10 ₹10
By Walter’s model, you are required to calculate the value of an equity share of each of the companies when
dividend payout ratio is (a) 20%. (b) 0%.
9. X Ltd. Presently considering two machines for possible purchase. Other information related to the machines are
as follows:
Machine – I Machine - II
Purchase price ₹50,000 ₹60,000
Estimated Life 4 years 4 years
Cash flows before depreciation and tax:
Year – 1 Year – 2 Year – 3 Year – 4

Machine-I 25,000 25,000 25,000 25,000
Machine-II 45,000 19,000 25,000 27,000
Rate of tax is 40%,
27,000
Compute net present value of each machine assuming cost of capital is 8%.
Which machine the company should buy?
The present value of ₹1 at 8% is as follows:
Y1=0.926. Y2= 0.857, Y3= 0.794, Y4= 0.735
(Assume straight line method of Depreciation).
10. Write short notes on the following:
(a) Accounting Rate of Return
(b) Capital Rationing
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1. Explain the functions of chief financial officer or manager in the modern business environment.
2. Sougata borrows from a bank 1,00,000 at 12% rate of interest to be paid in 5 equal annual instalments at the end
of each year. What will be the size of instalment? Given (PVIFA)(12,5) = 3.605
3. A sum of ₹5,000 is invested for 2 years at 10% interest rate compounded biannually. Find the maturity amount.
4(a). What do you mean by Capital Budgeting?
(b). What do you mean by discounted pay-back period method?
5. The following data relate to a firm:
(i)Earnings per share = ₹25,

(ii)Capitalisation rate = 12%
iii) Retention ratio = 40%
Determine the share price using Gordon’s Model if IRR is 15%
6. Discuss the features of optimum capital structure.
7. A firm has sales ₹5,00,000, variable cost of ₹3,50,000 and fixed cost of ₹ 1,00,000 and debt of ₹2,50,000 at 10%
rate of interest. You are required to calculate operating and financial leverages of the company. If the firm wants to
double its EBIT, how much of a rise in sales would be needed on a percentage basis?
Q.8. Discuss the role of debenture in company financing.
9. RIL Ltd. Opts for the following capital structure:
Equity Shares (100000 shares) ₹50,00,000

Total ₹100,00,000
The company is expected to declare a dividend of 5 per share. The market price per share is ₹50. The dividend is
expected to grow at 10%.
Compute Weighted Average Cost of Capital of RIL Ltd. Assuming 50% tax rate.
10. From the following information prepare a statement showing the estimated working capital requirement.
Projected annual sales: 26000 units. Selling price per unit 60

Analysis of selling price:
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Material: 40%, Labour :30%, Overhead: 20%, Profit:10%
Time lag (on average):
Raw materials in stock-3 weeks, Production process 4 weeks. Credit to debtors-5 weeks Credit from suppliers-3
weeks. Lag in payment of wages and overheads-2 weeks. Finished pods are in a warehouse-2 weeks.
Cash in hand is expected to be 10% of the net working capital.
11(a). What do you mean by internal rate of return? Discuss its accept and reject rule.
(b). Write short note on: Dividend Policy and Retained Earnings.
12.(a) Compute the pay-back period for the project:
(b). What do you mean by Profitability Index?
1.Discuss the importance of Financial Management.
2.Give an idea about ‘Wealth maximisation’ objective of financial management.
3.Mr. M is offered either to receive ₹10,000 three years from now or ₹14,000 five years from now, which one Mr.
M will accept? Assume rate of discount is 10%, [Given present value of 21 at 10% are 0.751 and 0.621 for 3rd and
5th year respectively.]
4.Explain ‘working capital cycle’.
5.Coltex Ltd, issue a new 10% Debentures of ₹1,000 each to be redeemed at par. However, it will involve flotation
cost of 4%. The company is in the 35% tax bracket. You are required to ascertain the cost of debt.
6.The Iron Ore Ltd. Consists of 4000 equity shares of ₹10 each. Currently these shares are quoted in the market at
2200 each. The earnings available to the equity shareholders at the end of the period 2,40,000. The earnings are
expected to grow 7%. What is the cost of equity capital?
7. (a) Write a short note on Marginal Cost of Capital.
b) Differentiate between Operating Leverage and Financial Leverage.
8. Calculate the degree of operating leverage, degree of financial leverage and combined leverage from the
following data: Sales 100000 units ₹2 per unit ₹22,00,000; Variable cost per unit@ ₹0.70, Fixed cost = ₹1,00,000;
Interest charges ₹3,000.
9.(a) Explain Trading on Equity” with example.
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(b) What do you mean by Optimum Capital Structure?
10. ABC Ltd, sells its products on a gross profit of 20% on sales. The following information is extracted from its
annual accounts for the current year ended 31st March, 2021.
₹
Sales at 3 months credit 40,00,000
Raw materials 12,00,000
Wages paid average time lag 15 days 9,60,000
Manufacturing expenses paid (one month arrear) 12,00,000
Administration expenses paid (one month arrear) 4,80,000
Sales promotion expenses (payable half yearly in advance) 2,00,000
The company enjoys one month’s credit from the suppliers of raw materials and maintains a 2 months’ stock of raw
materials and one-and-half month’s stock of finished goods. The cash balance is maintained ₹1,00,000 as
precautionary measure.
Assuming 10% margin, find out the working capital requirement of ABC Ltd.
11. Write short notes on:
(a) Commercial Paper
(b) Trade Credit as a source of short-term capital.
12. Raj and Co. Ltd. Has an investment project, the particulars of Which are given below:
Cost of the Asset ₹1,80,000

Installation charges ₹20,000
Effective working life = 10 years
Estimated scrap value ₹40,000
Annual profit before depreciation ₹56,000
Depreciation charged under straight line method and the rate of tax is given as 40% compute the pay-back period of
the project and state its acceptability.
13. (a) Why is discounted cash flow method superior to non-discounted cash flow method in evaluation of an
investment project?
(b) What is capital rationing?
14. The following figures are collected from the annual report of ABC Ltd.
Net Profit ₹60 lakhs

Outstanding 12% Preferences Shares ₹200 lakhs
Number of Equity Shares 3,00,000
Return on Investment 20%
Cost of capital 16%
Compute the amount of dividend to keep the share price at ₹84 using Walter’s Model.
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15. X Ltd. is contemplating, replacement of its one machines which has become outdated and inefficient. Its
financial manager has prepared a report of two possible replacement machines. The details of each machine are as
follows
Machine I Machine II
Initial Investment ₹15,00,000 ₹16,00,000
Estimated useful life 5 years 5 years
Residual Value ₹1,20,000 ₹1,00,000
Contribution per annum ₹11,60,000 ₹12,00,000
Fixed operating costs per annum ₹7,60,000 ₹6,90,000
Depreciation has been calculated by straight line method and has been included in fixed operating costs. The
expected cost of capital for this project is assumed as 12% p.a.
Required: Which machine is more beneficial.
Year 1 2 3 4 5
PV @ 12% 0.893 0.797 0.712 0.636 0.567
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Question
Practical
Working
Working Capital
Capital Management
Management (10 Marks)
[10 Marks]
1. Working Capital management
From the following informations of Sunshine Paints Ltd. You are required to determine the Working
Capital Requirements :
(i) Annual (expected) Sales ₹ 3,60,000
(ii) Analysis of Sales :-
Raw materials 50%
Expenses 30%
Profit 20%
(iii) Credit allowed to Debtors 2 ½ months
Credit allowed by Creditors l ½ months
Raw Materials in store 1 month
Processing period 2 months
Finished goods in Store 4 months
Bank Overdraft ₹ 1,00,000
Cash in hand for contingencies ₹ 6,000
Production is carried out evenly during the year and expenses accrue similarly.

From the following information of Bright Ltd., you are required to determine working capital requirement.
(a) Annual expected sales —₹ 1,20,000
(b) Analysis of sales :—
Material—60 %, Expenses—15 %; Profit—25 %;
(c) Credit allowed to Debtors —2 ½ months
(d) Credit allowed by Creditors — 1 ½ months
(e) Raw materials in store—1 month
(f) Processing Period—2 months
(g) Finished goods in store—3 months
(h) Bank overdraft —₹ 80,000
(i) Cash in hand for contingencies—₹ 5,000
(j) Production is carried on evenly during the year and expenses accrued similarly.
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From the following information prepare a statement showing estimated working capital requirement of
Woodpecker Ltd.:
Projected Annual Sales 5200 units
Selling price per unit ₹ 60
Analysis of selling price:
Material: 40%; Labour: 30%; Overhead: 20%; profit: 10%
Time lag on an average:
Raw material in stock 3 weeks
Production process 4 weeks
Credit to debtors 5 weeks
Credit from suppliers 3 weeks
Lag in payment of wages and overhead 2 weeks
Finished goods are in warehouse 2 weeks
Cash in hand is expected to be 10% of net working capital.

From the following information extracted from the books of Rubies Ltd, prepare a statement showing
the working capital requirement needed to finance a level of activity of 5200 units of output per annum:
Amount per unit (₹)
Raw materials 8
Direct labour 2
Overheads 6
Total Cost 16
Profit 4
Selling price
20
Raw materials are in stock on an average for-1 month
Materials are in process- month
Finished goods are in stock-6 weeks
Credit allowed by creditors-1 month
Credit allowed by debtors- 2 months
Log in Payment of wages-1 month
Cash in hand and at bank-₹ 7300
The production is carried on evenly during the year and wages and overheads accrue similarly.

From the following particulars of Moon Ltd. Determine the working capital requirement:
(a) Monthly Sales (expected): 10,000 units of ₹ 10 each.
(b) Analysis of Sales: Materials 40%, Labour 30%, Overhead ₹ 8,000 per week.
(c) Stock will include raw materials of ₹ 48,000 and 8,000 units of finished goods.
(d) Processing period – 2 weeks
(e) Credit to debtors – 5 weeks
(f) Credit from creditors – 1 month.
(g) Lag in payment of overhead – 2 weeks.
Production is carried on evenly during the year and expenses accrue similarly.
54 uestions nswers
53

From the following information prepare a Statement showing the Estimated Working Capital
Requirements:
(i) Projected annual sales 36,000 Units
(ii) Analysis of sales: ₹
Raw Materials 6 per unit
Labour 4 per unit
Overhead 3 per unit
Profit 2 per unit
Selling Price 15 per unit
(iii) Additional information:
Raw materials in stock 1 month
Production process 2 months
Finished goods in store 3 months
Credit allowed to debtors 4 months
Credit allowed by suppliers 2 months
Monthly wages and expenses are paid twice on 1st and 16th of each month.
(iv) Production is carried on evenly during the year and expenses and wages accrue similarly.
(iv) Cash is to be kept at 10% of the net working capital.

P & G Ltd. furnishes below its cost and other data:
Unit cost ₹
Raw material 30
Direct Labour 20
Overhead ?
Profit (25% on selling price) ?
Unit selling price 100
Additional information is as follows:
Average raw material;
in stock 1 month
in process ½ month
Credit allowed by suppliers 1 ½ Months
Credit allowed to debtors 3 month
Time lag in payment
Wages ½ month
Overhead 1 month
Cash balance is assumed to be ₹ 1,00,000 and 70% of sales are credit sales. Assuming that production is
carried on evenly throughout the year, you are required to determine the working capital requirement of the
P & G Ltd. to achieve an output level of 1,20,000 units p.a.
uestions nswers 55
Gobind Kumar Jha
A trading company's forecast sales and other particulars are given below:
Forecast annual sales ₹ 1,30,000
Net Profit on cost of sales 25%
Average credit allowed to Debtors 8 weeks
Average credit allowed by Creditors 6 weeks
Average stock carrying (to meet sales) 4 weeks
Determine forecast working capital of the company. Estimated cash on hand and at Bank ₹ 5,000.

The components of current assets of a new trading concern are Stock, Debtors and Cash. The only
component of its current liabilities is Creditors. Ascertain the concern's working capital requirement for the
first year from the following information:
(a) Expected sales (20% cash) at a profit of 20% on cost: ₹ 9,00,000
(b) Expected stock turnover : 6 times
(c) Expected credit period to Debtors: 2 months
(d) Expected credit period from creditors: l ½ months.
(e) The concern intends to maintain a cash balance equal to 1 month's cash sales.
10.Working Capital management

Mrs. Sen wants to start a new trading business and gives the following information :
(a) The projected annual sales - ₹ 24,00,000.
(b) Her expenses are estimated as fixed expenses ₹ 10,000 per month plus variable expenses equalto
five percent of her turnover.
(c) Percentage of gross profit on cost of purchase will be 25%.
(d) Average expected credit period allowed to debtors – 2 months.
(e) Average expected credit period allowed by suppliers – 1.5 months.
(f) She expects to turnover her stock 6 times in a year.
(g) Average cash holding - 1 month expenses.
You are required to forecast her working capital requirement.

For a new business Mr. Bose supplied the following information:
(a) The project annual sales – ₹ 1,20,00,000
(b) He has estimated fixed expenses ₹ 20,000 per month and variable expenses equal to two percent of
turnover.
(c) Percentage of gross profit on cost of purchase will be 25%.
(d) Average expected credit period allowed to debtors – 1 month.
(e) Average expected credit period from suppliers – 15 days.
(f) He expects to turnover his stock 5 times in a year.
(g) Average cash holding – 1 month’s expenses.
You are required to forecast his working capital requirement.
56 uestions nswers

Determine the working capital requirement from the following particulars.
Annual budget figures for ₹ lakhs
Raw Materials 480
Direct Wages 240
Overheads 180
Sales 1000
Additional Information:
(a) Average stock level of raw materials - 18 days.
(b) Credit sales : 20 days credit is normal
(c) Finished goods are held in stock for a period of 10 days before they are released for sale,
(d) Process period is for 12 days.
(e) The company enjoys 30 days credit facilities for purchases.
(f) Estimated Cash and Bank Balance: 10 % of total working capital
Assumptions:
(a) I year = 360 days.
(b) Raw materials are introduced at the beginning of manufacturing process and labour & O/H accrue
evenly.

The production capacity of Quick Profit Ltd. is 5,20,000 units per annum. Due to power crisis, the
Company can operate at 80% of the capacity level. You are asked to ascertain the Working Capital
requirement at the current level of operation. Add 10% to your computed figure, to allow for contingencies:
Other information :
(a) Selling Price—₹ 20 per unit.
(b) Elements of cost (per unit):
Raw Materials—40% of selling price, (ii) Labour—30% of selling price, (iii) Budgeted overhead
₹ 32,000 per week. Overhead includes depreciation ₹ 8,000 per week.
(c) Planned Stock will include 24,000 units of finished goods.
(d) Time lag information:
(i) Raw materials in stores—3 weeks (ii) Materials will stay in process—2 weeks (iii) Credit allowed
to debtors—5 weeks (iv) Credit allowed by creditors—1 month, (v) Lag in payment of wages and
overhead— 1/2 month.
(e) 25% of Sales may be considered to be for cash. Assume that production is carried on evenly
throughout the year and Wages and Overhead accrue similarly.
(f) A time period of 52 weeks is equivalent to a year and a month comprises 4 weeks.
57
uestions nswers 56
Gobind Kumar Jha

From the following details concerning a manufacturing enterprise, estimate the amount of working capital
needed to finance an activity level of 50%. The capacity of the concern is to produce 2,40,000 units
p.a.
Expected selling price: ₹ 10.00 per unit
Cost of raw materials: ₹ 3.00 per unit
Direct labour cost: ₹ 2.50 per unit
Annual overheads at 50% activity level
(Including depreciation of ₹ 50,000) ₹ 2,50,000
Additional Information:
(a) Raw materials are in stock, on an average, for one month.
(b) Materials are in process, on an average, for two months.
(c) Finished goods are in stock, on an average for two months.
(d) Credit allowed to debtors is for three months.
(e) Credit received from suppliers of raw materials is for one month.
(f) Lag in payment of wages half a month and of overheads one month.
(g) Cash in hand and at bank 10% of net working capital.
You may assume that production is carried on evenly throughout the year and overheads accrue
similarly. One-fourth of the output is sold against cash.

From the following information presented by a manufacturing company, prepare a working capitalrequirements
forecast statement for the coming year:
(a) Expected monthly sales—32,000 units @.₹ 10 per unit.
(b) The anticipated ratios of cost to selling price are: Raw materials: 40%, Labour: 30%, Budgeted
overhead: ₹ 16,000 per week; Overhead expenses include depreciation of ₹ 4,000 per week.
(c) Planned stock will include raw materials for ₹ 96,000 and 16,000 units of finished goods.
(d) Materials will stay in process for 2 weeks.
(e) Credit allowed to debtors is 5 weeks.
(f) Credit allowed by creditors is 1 month.
(g) Lag in payment of overhead is 2 weeks.
(h) 25% of sales may be assumed against cash and cash-in-hand is expected to be ₹ 25,000
(i) Assume that production is carried on evenly throughout the year and wages and overheads accrue
similarly. A time period of 4 weeks is equivalent to a month.
58 uestions nswers
57
16.Working Capital management]

From the following details concerning a manufacturing enterprise, estimate the amount of working capital
needed to finance an activity level of 60%. The capacity of the concern is to produce 2, 00,000 units p.a.
a. Expected selling price ₹ 25
b. 40% of selling price is the cost of raw materials.
c. 20% of selling price is the cost of labour
d. Overhead (including depreciation ₹1, 20,000) –₹ 6, 00,000.
e. Planned stock will include raw material for ₹ 1, 50,000 and 20,000 units of finished goods.
f. Materials will stay in process for 1 month.
g. Credit allowed to debtors 1.5 months
h. Credit allowed by creditors 2 months
i. Lag in payment of wages is 0.5 months
j. 40% of purchases and 20% of sales may be assumed to be made against cash.
k. Bank overdraft ₹ 2, 00,000.
l. Cash in hand is expected to be ₹ 82,000.
m. Production is carried on evenly during the year and wages and overheads accrue in the same way.

The following particulars are available from cost records of a company:
Elements of cost Amount per unit
₹
Raw Materials 24
Labour 9
Overhead 18
Total cost 51
Profit 9
Selling Price 60
Further information:
(1) Raw materials are in stock – one month.
(2) Materials are in process – half a month.
(3) Finished goods are in stock – one month.
(4) Credit allowed by suppliers – one month.
(5) Credit allowed to debtors – two months.
(6) Lag in payment of wages – 1.5 weeks.
(7) Lag in payment of overhead expenses – one month.
(8) 25% of output is sold against cash.
(9) Cash on hand and at bank is expected to be ₹ 10,000.
You are required to prepare a statement showing the working capital needed to finance a level of
activity of 1,56,000 units of annual production. It may be assumed that production is carried on
evenly throughout the year, wages and overheads accrue similarly and a time period of 4 weeks is
equivalent to a month.
uestions nswers 59
Gobind Kumar Jha

Estimate the working capital requirement on profit basis for the coming year from the following
information of a manufacturing company. expected annual sales is 1,56,000 units of Rs. 10 per unit. The
anticipated ratios of cost to selling price are: Raw material 50% and direct wages 15%. Budgeted cash
overhead is Rs. 42,000 and depreciation is Rs. 10,000 per annum. Planned stock will include raw materials
for Rs. 45,000 and 9,000 units of finished goods. Credit allowed to debtor is 1 month. Credit expected to be
received from suppliers in 3 weeks. Overhead and wages payment will be made 1 week after their
occurrence. Material will stay in the process of 14 days. Cash in hand to be maintained is 15% of total
working capital. Assume that production is carried on evenly throughout the year. Raw materials are
introduced at the beginning of the process and wages and overhead accrue evenly during processing.
From the following information presented by a manufacturing company, estimate the working capital

requirement for the coming year.
The monthly sales volume is expected to be 40,000 units at Rs. 20 per unit. The anticipated ratios of
different elements of cost to selling price are: Raw material-50%, Labour-25%. It is estimated that budgeted
overhead per week will be Rs. 20,000 including depreciation on Rs. 5,000. Planned stock will include raw
material for Rs. 1,50,000 and finished stock 20,000 units. Credit period allowed to debtors is 3 weeks.
Credit period expected to be received from suppliers is 2 weeks. Overhead payment will be made 1 week
after incurring expenses. Wages will be paid at the beginning of the week following the week of the work.
The average processing period of each unit will be 7 days.
Cash in hand to be maintained for contingencies is Rs. 20,000. Arrangement of bank overdraft to the extent
of Rs. 1,00,000 has been made. Assume that production is carried n evenly throughout the year and
overhead accrue similarly.

A manufacturing company has a capacity to produce 60,000 unit p.a. The cost structure at that capacityand
selling price p.u. are given below:
Material ₹ 5
Labour ₹ 2
Overhead ₹ 5
(60% variable; of the fixed overhead ₹ 30,000 represents depreciation)
Total cost ₹ 12
Profit ₹ 3
Selling Price ₹ 15 The
other details are-
Raw material storage period – 2 months; Processing time – 1 month and Finished Goods in storage - 1
month.
Debtors and Creditors turnover are 6 and 12 times a year respectively.
Lag in payment of overhead is 1/2 month.
Assuming that the company will be able to utilise 80% of its capacity-estimate the working capital
requirement on cash cost basis.
60 uestions nswers

Bengal Paints Ltd. sells its products on a gross profit of 20% on sales. The following information is
extracted from its annual accounts for the year ending 31st December, 2008:
₹
Sales at 3 months credit 40, 00,000
Raw Materials 12, 00,000
Wages paid – 15 days in arrears 9, 60,000
Manufacturing expenses – 1 month in arrears 12, 00,000
Administrative expenses – 1month in arrears 4, 80,000
Sales promotion expenses payable ½ years in advance 2, 00,000
Income Tax (payable quarterly last installment falls due in Dec, 2008) 4, 00,000
The company enjoys one month’s credit from supplier of raw materials and maintains 2 months
stock of raw materials and 1.5 months stock of finished goods. Cash balance is maintained at
₹ 1, 00,000 as a precautionary balance. Assuming 10% margin, find out net working capital
requirement of the company.

Cosmos Ltd. sells its product on a gross profit of 20% on sales. The following information is extracted
from its annual account for the current year ended 31st March, 2014.
₹
Sales at 3 months credit 80,00,000
Raw materials 24,00,000
Wages paid-average time lag 15 days 19,20,000
Manufacturing expenses paid-one month in arrears 24,00,000
Administration expenses paid-one month in arrears 9,60,000
Sales promotion expenses-payable half-yearly in advance 4,00,000
The company enjoys one month’s credit from the suppliers of raw material and maintains a 2 month’s stock
of raw materials and one-and-half month’s stock of finished goods. The cash balance is maintained at ₹ 2,
00,000 as precautionary measures. Assuming 10% margin, find out of the working capital requirement of
Cosmos Ltd.

B Ltd. Supplies you the following informations.
₹
(i) Sales (at 2 months credit) 36,00,000
(ii) Materials consumed (suppliers extend 2 months credit) 9, 00,000
(iii) Wages paid (lag in payment – 1 month) 7, 20,000
(iv) Manufacturing expenses outstanding at the end of the year
(lag in payment – 1 month) 80,000
(v) Total administrative expenses paid
(lag in payment – 1 month) 2, 40,000
(vi) Sales promotion expenses paid quarterly in advance 1, 20,000
The company sells its products at a gross profit of 25% counting depreciation as part of the cost of
production. It keeps one month’s stock of each of raw materials and finished goods and a cash balance of
₹ 1, 00,000. Assuming a 20% safety margin, work out the working capital requirement of the company on
cash – cost basis. Ignore work-in-progress.
uestions nswers 61
Gobind Kumar Jha

From the following information of A Ltd., calculate (a) Net operating cycle period (b) Number of operating
cycles in a year.
(a) Raw material inventory consumed during the year ₹ 6,00,000
(b) Average stock of raw material ₹ 50,000
(c) Cost of Production ₹ 5,00,000
(d) Average Work-in-progress inventory ₹ 30,000
(e) Cost of Goods Sold ₹ 8,00,000
(f) Average finished goods stock held ₹ 40,000
(g) Average collection period from debtors 45 Days
(h) Average credit period availed 30 Days
(i) No of days in a year 360 Days
[Net operating Cycle period: 85 Days; Number of operating cycle period = 360/85 = 4.2 times]

From the following data, compute the Duration of operating cycle (money block period) (₹ in 000)
Stock: Raw Materials 20
W.I.P 14
Finished Goods 21
Purchases 96
Cost of goods sold 140
Sales 160
Debtors 32
Creditors 16
1 year = 360 days.

Between two periods of a company there is an increase of debt collection period and raw material
conversion period by 20 days and 5 days respectively, whereas its creditors payment period and finished
goods conversion period is reduced by 10 days and 5 days respectively. Calculate the change in operating
cycle of the company.

The following information is provided by X Ltd. for the year ending 31.3.2017.
Raw Material storage period 45 days
WIP Conversion period 18 days
Finished Goods storage period 22 days
Debt Collection period 30 days
Creditors payment period 55 days Annual
cash cost of Operation Rs. 18 Lakhs(1
year = 360 days)
Compute (i) Net operating cycle period (ii) Number of operating cycles in a year.
62 uestions nswers
Leverage (10 Marks)
Leverage [10 Marks]

Income Statement of PQR Ltd.
Units manufactured and sold .......................................................................................... (Q)
Selling price per unit… .................................................................................................. (S)
Variable cost per unit .................................................................................................... (V)
Sales / Total Revenue ................................................................................................. [(QXS)]
Less: Total variable cost….......................................................................................... [(QXV)]
Contribution ................................................................................................................. (C)
Less: Fixed Operating Cost… ..................................................................................... (F)
Earning Before Interest and Tax/ Operating Profit .................................................. (EBIT/OP)
Less: Interest on debt .....................................................................................................(I)
Earning Before Tax ................................................................................................... (EBT)
Tax @ 50% ................................................................................................................... (T)
Earning After Tax ......................................................................................................... (EAT)
Less: Preference Dividend.................................................................................................. (P)
Earning Available to Equity Shareholders/ Equity Earnings ........................................... (Ee)
Number of Equity Shares .............................................................................................. (N)
Earning Per Share......................................................................................................... (EPS)
1. Leverage
D Limited Furnishes the following results for the year 2004-05:
Sales 2,00,000 units @ ₹ 100 per unit
Variable cost ₹ 40 per unit
Operating fixed cost (i.e. Depreciation, rent, salary etc.) ₹ 60,00,000
Financial Fixed cost (i.e. interest on borrowed capital) ₹ 20,00000
Compute (a) DOL ; (b) DFL; (c) DCL
2. Leverage
The particulars of three firms X, Y and Z are given below. Calculate DOL; DFL and DCL
X Y Z
Sales Value (₹) 50,000 50,000 50,000
Variable cost (₹) 30,000 20,000 15,000
Fixed cost (operating) (₹) 10,000 20,000 25,000
Fixed Financial Cost (₹) 3,500 2,000 1,000
3. Leverage
From the following information calculate Degree of operating Leverage (DOL), Degree of Financial
Leverage (DFL) and Degree of Combined Leverage (DCL):
a) Sales Rs. 9,60,000
b) Variable Cost Rs. 5,60,000
c) Fixed Cost Rs. 2,40,000
d) Interest Rs. 60,000
uestions nswers 63
Gobind Kumar Jha
4. Leverage
Megabyte Ltd made a sale of ₹ 20, 00,000. Variable cost was ₹ 14, 00,000. Fixed cost was ₹ 4, 00,000 and
Debt ₹ 1, 00,000 @ 10% interest per annum. Determine the degree of operating and financial leverage of
the company.
5. Leverage
A simplified income statement of Fortune Ltd. Is given below:
Sales ₹ 12, 00,000
Variable cost ₹ 9, 00,000
Fixed cost ₹ 1, 00,000
EBIT ₹ 2, 00,000
Interest ₹ 70,000
Tax (30%) ₹ 39,000
Net Income ₹ 91,000
Calculate the following:
i. Degree of Operating Leverage
ii. Degree of Financial Leverage
iii. Degree of Combined Leverage
6. Leverage
Calculate different types of Leverages and EPS of ABC Ltd. from the following information:
Equity share capital (12,000 shares @ Rs. 10 each) Rs. 1,20,000
Retained Earnings Rs. 40,000
10% Debentures Rs. 1,60,000
Turnover Rs. 12,00,000
Fixed operating cost Rs. 1,00,000
Variable operating cost ratio 40%
Income tax rate 40%
7. Leverage
Calculate different types of Leverages from the following data:
Sales : 50,000 units @ ₹ 40 per unit
Variable cost per unit : ₹ 12
Operating Fixed Costs : ₹ 5, 00,000
Shareholders’ fund : ₹ 20, 00,000
Debt equity Ratio : 1.5:1
Rate of Interest : 10%
8. Leverage
If the combined leverage and operating leverage of a company are 2.5 and 1.25 respectively, find the
financial leverage and P/V ratio; given that the equity dividend per share is ₹ 2, interest payable per year is ₹
2 lakhs, total fixed cost ₹ 1 lakh and sales ₹ 20 lakh.
64 uestions nswers
9. Leverage
Calculate the PBT and Financial Leverage ifNet
Worth = Rs 25 lakhs ;
Debt / Equity = 3:1;
Interest rate = 12% ;
Operating Profit = Rs 20 lakhs.
10.Leverage
The following information is available in respect of a manufacturing company :
Sales: 50,000 units
Selling price per unit: ₹ 20
Variable Cost per unit : ₹ 15
Fixed Cost: ₹ 40,000
Applicable tax rate: 40 %
The capital structure of the company is as follows:
10,000 Equity shares of ₹ 10 each : ₹ 1,00,000
5,000 10% preference shares of ₹ 10 each : ₹ 50,000
12% Debenture : ₹ 1,00,000
Total ₹ 2,50,000
Calculate (a) EPS (i.e. earning per share); (b) DOL (c) DFL (iv) DCL i.e. DTL (degree of total
leverage)
11.Leverage
From the following information of Trends Ltd. calculate the degree of Operating Leverage, Financial
Leverage and Combined Leverage for each situations A and B under financial plans I, II and III. Also
indicate which of the above plans is most risky and which one is least-risky.
Production and Sales 1000 units
Selling price per unit ₹ 20
Variable cost per unit ₹ 15
Fixed cost (Operating) :
Situation — A ₹ 3,000
Situation — B ₹ 4,000
Capital Structure :
Plan I II III
₹ ₹ ₹
Equity 7,000 5,000 3,000
10 % Debt 3,000 5,000 7,000
10,000 10,000 10,000
uestions nswers 65
Gobind Kumar Jha
12.Leverage
Relevant information about three companies are given below :
BIL PIL MIL
Annual Production Capacity (units) 1,00,000 1,50,000 2,50,000
Capacity Utilisation and sales 75% 75% 75%
Unit selling price (₹) 40 50 50
Unit variable cost (₹) 15 15 20
Fixed cost p.a. (₹) 2,00,000 3,00,000 5,00,000
Equity Capital (₹) 5,00,000 7,00,000 10,00,000
(1,000 shares for each company)
10% Preference Capital (₹) --------- 50,000 1,00,000
15% Debenture (₹) 1,00,000 2,00,000 3,00,000
Calculate operating leverage, financial leverage, combined leverage and EPS of these three companiesand
comment.
13.Leverage
From the following information, compute sales : DOL-2; DFL-3, interest ₹ 3,00,000 and
contribution is 40% of sales.
14.Leverage
The following details of A Ltd. for the year ended 31.03.2005 are furnished
Operating Leverage 3:1
Financial Leverage 2:1
Interest charges per annum ₹ 20 lakhs
Corporate tax rate 50 %
Variable cost as a percentage of sales 60 %
Prepare the income statement of the company.
15.Leverage
Given the following information:
Sales (10,000 units) ₹ 10, 00,000
Variable cost per unit ₹ 60
Interest ₹ 1, 00,000
EBT ₹ 2, 00,000
DCL 2.5
Calculate Operating Leverage and Financial Leverage
66 uestions nswers
16.Leverage
The capital structure of R Limited comprises only Equity Share Capital of ₹ 20 lakhs (20,000 equity shares
of ₹ 100 each). The authorised share capital of the company is 40,000 shares. The management of R
Ltd is planning for an expansion scheme that will require a capital of ₹ 10 lakhs. The financing options
are :
(a) Entirely by Equity Share Capital
(b) 50% by Equity and the balance by 6 % Debenture.
(c) Entirely by 6% Debentures.
(d) 50% by Equity and 50% by Preference shares of ₹ 100 each with 5% dividend.
Expected EBIT will be ₹ 10 lakhs. The company is in a 40% tax bracket. Which alternative
financing plan do you recommend and why?
17.Leverage
XYZ LTD. has currently a capital of ₹ 100 lakhs consisting of equity shares of ₹ 100 fully paid. Its
authorised capital is 2 lakhs shares of ₹ 100 each. A new project costing ₹ 50 lakhs is under consideration.
In order to finance this project four alternative financing plans are suggested as follows :
(a) Entirely by Equity Shares.
(b) ₹ 25 lakhs by Equity Shares and the balance by 14% Debentures.
(c) Entirely by 14% Debentures.
(d) ₹ 25 lakhs by 14% Debentures and the balance by 18% Bank loan.
The company's EBIT after expansion will be ₹ 25 lakhs.
You are required to comment on the alternative financing plans with reference to the risk and return
involved. Assume corporate tax rate of 40%.
18.Leverage
Anurup Ltd. Has equity share capital of ₹ 5, 00,000 divided into shares of ₹ 100 each. It wishes to raise
₹ 3, 00,000 for expansion – cum – modernisation scheme. The company plans the following financing
alternatives
i. By issuing Equity Shares of ₹ 100 each
ii. ₹ 1, 00,000 by issuing Equity Shares of ₹ 100 each and ₹ 2, 00,000 through issue of 10%
Debenture.
iii. By raising loan at 10% per annum.
iv. ₹ 1, 00,000 by Equity Shares of ₹ 100 each and ₹ 2, 00,000 by issuing 8% Preference Shares of
₹ 100 each.
You are required to suggest the best alternative giving your comment assuming that the estimated
earnings before interest and taxes (EBIT) after expansion is ₹ 1, 50,000 and corporate rate of tax is 35%.
19.Leverage
A company is expanding its activity for which it needs ₹ 20, 00,000. It has the following three
alternative financial plans:
i. It can issue 20,000 equity shares of ₹ 100 each
ii. It can issue 10,000 equity shares and 10,000 preference shares, both of ₹ 100 each. The
preference shares will carry 12% dividend.
uestions nswers 67
Gobind Kumar Jha
iii. It can issue 10,000 equity shares of ₹ 100 each and raise term loan of ₹ 10, 00,000 at 14%
rate of interest.
Show the earnings per shares under the three different financing plans when EBIT levels are ₹ 1, 00,000,
₹ 2, 00,000, ₹ 3, 00,000, ₹ 4, 00,000. Which plan would you recommend and why? The present corporate
income tax rate is 50%.
20.Leverage
The Capital structure of ABC Company Ltd. is given below :
₹ In lakhs
Equity Share Capital (₹ 100 each) 5.00
Retained Earnings 2.50
14 % Debenture 2.50
10.00
The company wants to undertake an expansion scheme of ₹ 6 lakhs which can be finance.
(i) Entirely by issue of Equity Shares or
(ii) By 12 % Debentures of ₹ 100 each at par.
As a result of expansion, sales and operating fixed cost will increase by 50% and 100%
respectively. The present operating details are as follows:
Sales ₹ 20 lakhs
Variable cost 60% of sales
Operating fixed cost : ₹ 2 lakhs
Corporate tax 40%
Calculate leverages and EPS before and after expansion and give your recommendation.
[EPS: ₹ 67.80, ₹ 41.73 & ₹ 83.16]
[Recommendation:
On the basis of above calculation it is recommended that the company should go for the expansion
scheme of ₹ 6 lakhs and it is to be financed entirely by 12% Debentures as EPS will be maximum on
expansion scheme under financing plan. But the debt in the capital structure increases the financial
risk of equity shareholder causing regular drainage of profit and may be responsible for the
insolvency and even bankruptcy of the company.]
21.Leverage
A company has the choice of issuing 10% debentures or ₹ 100 equity shares to raise ₹ 20 lakh to meet
its long-term investment requirements. Its current capital structure consists of 20000 ordinary shares of
₹ 100 each, 8% debentures of ₹ 10, 00,000 and 12% preference shares of ₹ 10, 00,000. Determine the
level of EBIT at which EPS would be the same, whether the new funds are acquired by issuing ordinary
shares or by issuing 10% debentures. Tax rate is assumed to be 50%. (Ignore dividend distribution tax).
Also, construct EBIT-EPS chart assuming various levels of EBIT.
22.Leverage
A firm has sales of ₹ 5,00,000, variable cost of ₹ 3,50,000 and fixed cost of ₹ 1,00,000 and debt of
₹ 2,50,000 at 10% rate of interest. What is Combined Leverage ? If the firm wants to double its
EBIT, how much of a raise in sales would be needed on a percentage basis ?
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23.Leverage
ITC Limited sells its product “X” at a price of ₹ 100 each. The variable cost per unit is ₹ 40 whereas
the total fixed cost is ₹ 2,00,000 which is expected to be fixed in near future. The companyis at present
selling 5,000 units p.a.
(a) Compute the EBIT and degree of operating leverage at the present level of sales.
(b) If the sales volume goes 20% up or down what would have been the effect on EBIT?
(c) Recompute the DOL taking the changed levels.
24.Leverage
PQR Limited has earnings before interest and taxes of ₹ 2,00,000. The company has 12%Debentures
of ₹ 10,00,000, 15% Preference share capital of ₹ 2,00,000 and 25,000 equity shares of
₹ 10 each in its capital structure. Tax rate 40%.
(a) Compute the degree of financial leverage (DFL) and EPS at the present level of EBIT.
(b) Compute the percentage changes in EPS if the EBIT—(i) increases by 40% ; (ii) decreases by
40%
(c) Recompute the DFL at the changed levels of EBIT
25.Leverage
Zica Ltd. provides you the following information:
Capital structure 12% Debenture Rs. 2,00,000; 9% Preference Share Capital Rs. 3,00,000 and 4,000
Equity Shares of Rs. 100 each.
Revenue and operating cost details: Sales 3,000 units @ 600 p.u.; Variable Operating cost p.u. Rs. 350;
Fixed Operating Cost Rs. 3,20,000.
Corporate income tax rate and Dividend Distribution Tax rate may be assumed at 30% and 10%respectively.
Calculate DOL, DFL and DCL of Zica Ltd. using the concept of leverage; find the percentage changesin
EPS when sales increase by 10%
26.Leverage
A company provides you with the following information: Capital structure –
Rs.
10,000 equity shares of Rs. 10 each 1, 00,000
Debenture ---------
EBIT 2, 00,000
Tax Rate 50%
Change in EBIT 20%
Show the effects of proposed change in EBIT on EPS and comment on it.
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Cost of Capital (10 Marks)
Cost of capital [10 Marks]

1. Cost of capital
A company's share is currently quoted in the market at ₹ 20. The company pays a dividend of ₹ 2per
share and the investors expect a growth rate of 5% per year. You are required to calculate (a)Cost of
equity capital of the company and (b) the market price per share, if the anticipated growth rate
dividend is 7%.
2. Cost of capital
The market value of each share of the firm is ₹ 4. The company Paid Dividend ₹ 1 last year. The
investor except 5% growth in the rate of dividend each year. You are required to ascertain (a) cost of
equity share of the firm (b) market value of each equity share if the expected growth rate becomes 8%.
3. Cost of capital
T Limited has 2,00,000 equity share of ₹ 10 each. The current market price is ₹ 50 and the earnings
available to the equity shareholders at the end of the period is ₹ 8,00,000. The earnings areexpected to
grow @ 8% p.a. Please compute the cost of equity share under earnings growth model.
4. Cost of capital
The equity shares of a company is currently (i.e. at the end of 2015) selling in the market at Rs. 300 (F.V is
Rs. 100 each). It is known that the company has paid a dividend of Rs. 30 in 2014 and it has a steady
growth rate of 4% per year. Find its cost of equity.
5. Cost of Capital
The market price of the equity share of X Ltd. is ₹ 9 (face value ₹ 10 per share). The company is expected
to declare a dividend 25%. If dividend is expected to fall @ 3% every year, calculate the cost of equity
share capital.
6. Cost of Capital
XYZ Ltd. has its share of ₹ 100 each quoted on the stock exchange; the current market price per share
is ₹ 240. The dividend per share over the last four years has been ₹ 12.00, ₹ 13.20, ₹ 14.50 and ₹
16.00. Calculate the cost of equity share.
7. Cost of capital
DKP Limited issues 15% irredeemable preference shares of ₹ 1,000 each. The floatation costs are 2
% on the Issue price of preference shares. Compute the cost of preference shares if they are issuedat
—
(a) par;
(b) a premium of 10%;
(c) a discount of 10%.
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8. Cost of capital
From the following details ascertain the specific cost of each source of capital:
A company collects ₹ 95,000 by the issue of 1,000 10% irredeemable preference shares of ₹ 100
each at a discount of 5%. The floatation cost for the purpose had been ₹ 4,750. What is the cost of
preference shares?
9. Cost of Capital
G Limited issues 12% irredeemable preference shares of ₹ 100 each at a premium of 5%. The floatation
cost is 2% on issue price. The dividend distribution tax under section 115-0 of the Income Tax Act is
16.995 % (i.e., tax @ 15 % plus 10 % surcharge plus 3% education cess). Please compute the cost of
preference shares.
10.Cost of Capital
X & Co. has issued 12% redeemable preference shares of face value ₹ 100 for ₹ 10 lakh. The shares are
expected to be sold at 5% discount; it will also involve floatation cost of ₹ 5 per share. The shares are
redeemable at a premium of 5% after 1 0 years Calculate the cost of capital of redeemable preference share,
if the rate of tax is 50%. Ignore dividend tax
11.Cost of capital
A company issues 12% redeemable preference shares of ₹ 100 each at 5 % premium redeemable
after 15 years at 10% premium. If the floatation cost of each share is ₹ 2, what is the value of Kp
(Cost of Preference share) to the company?
12.Cost of capital
JK Ltd. Issues – 10,000, 10% preference shares of ₹ 100 each at a premium of 10% but redeemable at a
premium of 15% after 5 years The cost of issue is ₹ 5 per share. You are required to determine the cost of
preference share capital.
13.Cost of Capital
Y Co. Ltd. issues 10,000 12% Preference Shares of ₹ 100 each at a premium @ 10 % but redeemable ata
premium @ 20 % after 5 years The Company pays underwriting commission 5%. If tax on dividend is
12.5 %, surcharge is 2.5% and education cess is 3 %, calculate the cost of Preference Share Capital.
14.Cost of Capital
Z Ltd. issued 10,000, 12% preference shares of Rs. 100 each at a premium of 10%. The flotation cost was
5% on issue price. The preference shares will be redeemed at a premium of 20% after five years. The tax
rate applicable to the company is 30%. The corporate dividend tax is 10%. Compute cost of preference
shares of Z Ltd.
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15.Cost of Capital
P Ltd. issued ₹ 10, 00,000, 11% preference shares of ₹ 100 each. The flotation cost was @ 2% on issue
price. The preference shares will be redeemed at a premium of 5% after 5 years The tax rate applicable to
the company is 30%. The Corporate Dividend Tax is 10%. Compute the cost of preference shares ofP Ltd.
16.Cost of capital
BKP Limited issues 10% debentures of ₹ 10,000 each to be redeemed after 10 years The company is
in the 35% tax bracket. Compute the cost of debentures issued at a discount of 10% and redeemable at a
premium of 10%, Floatation cost is 2% on issue price.
17.Cost of capital
Rima & Co. has issued 12% Debenture of face value ₹ 100 for ₹ 10 lakh. The debenture is expected tobe
sold at 5% discount. It will also involve floatation costs of ₹ 5 per debenture. The debentures are
redeemable at a premium of 5% after 10 years Calculate the cost of debenture if the tax rate is 50%.
18.Cost of Capital
Find out the cost of retained earnings from the following informationCost
of capital=10%, brokerage cost =2% and tax rate =50%
19.Cost of capital
The following information is extracted from the books of A Ltd:
Capital structure---
Source ₹ After tax cost
Equity Shares Capital 4,00,000 16%
Retained Earning 1,00,000 16.5%
Preference Share Capital 3,00,000 12%
Debenture 2,00,000 10%
10,00,000
Calculate the weighted average cost of capital on the basis of book value weights.
20.Cost of capital
ABC Ltd has the following capital structure:
₹
Equity share Capital (expected dividends 15%) 8,00,000
12% Preference Share Capital 5,00,000
10% Debenture 4,00,000
8% Long-Term Loan 3,00,000
You are required to calculate the weighted average cost of capital before and after tax, assuming 40% as the
rate of income tax.
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21.Cost of Capital
The Capital structure and specific cost of capita! (after tax) of a company are given below: Sources
Book Value After Tax
Rs. in lakh Cost %
Equity Share Capital (Share of ₹ 10 each) 200 18
Retained Earnings 100 18

Long-term Debt 200 6
500
The present market value of equity is ₹ 90 per share. Corporate tax rate is 40%.
(1) Calculate weighted average cost of capital using:
(i) Book values as weights
(ii) Market values as weights.
22.Cost of Capital
RIL Ltd", opts for the following capital structure:
Equity Shares (1,00,000 shares) ₹ 50,00,000
15% Debenture ₹ 50,00,000
Total ₹ 1,00,00,000
The company is expected to declare a dividend of ₹ 5 per share. The market price per share is ₹ 50. The
Dividend is expected to grow at 10 %. Compute weighted average cost of capital of RIL Ltd. assuming 50
% tax rate.
[Weighted Average Cost of Capital 13.75%; cost of Equity 20% and cost of Debenture (after tax)
= 7.5%]
23.Cost of capital
XYZ Ltd., has the following book value capital structure :
₹ (in Lakhs)
Equity Capital (in shares of Rs 10 each, fully paid up-at par) 150
11% Preference Capital (in shares of Rs 100 each, fully paid up - at par) 10
13.5% Debentures (of Rs 100 each) 100
15% Term Loans 125
585
The next expected dividend on equity shares per share is Rs 3.60 ; the dividend per share is expected
to grow at the rate of 7 %. The market price per share is Rs 40. Preference stock redeemable after ten
years is currently selling at Rs 75 per share. Debentures redeemable after six years are selling at Rs 80
per debenture. The Income-tax rate for the company is 40 %.
You are required to calculate the weighted average cost of capital using (a) book value proportions ;and
(b) market value proportions.
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24.Cost of capital
Indrani Ltd. has the following capital structure:
₹ (in Lakhs)
Equity share capital (10 lakhs shares) 100
12% Preference share capital (10,000 shares) 10
14% Debentures (70,000 Debentures) 70
14% Term Loan 100
400
The market price per equity share is ₹ 25. The next expected dividend per share is ₹2 and is expected
to grow at 8%. The preference shares are redeemable after 7 years at per and are currently quoted at 75 per
share. The debentures are redeemable after 6 years at par and their current market quotation is ₹ 90 per
debenture. The tax rate applicable to the firm is 50%.
You are required to compute weighted Average cost of capital of the company using (a) Book Value,
(b) Market Value as weights.
25.Cost of capital
T Ltd. has the following capital structure:
Rs. (in lakhs)
Equity Share Capital (10 lakh shares) 100
14% Debentures (70,000 Debentures) 70
16% Term Loan 100
400
The market price per equity share is Rs. 25. The next expected dividend per share is Rs. 2 and is
expected to grow 8%. The debentures are redeemable after six years at par and the current market
quotation is Rs. 90 per debenture. The tax rate applicable to the firm is 50%.
You are required to compute the weighted average cost of capital of the company using market value
as weight.
26.Cost of capital
The capital structure and other information of a company are given below:
Source Amount ₹ in lakh After-tax cost of Capital (%)
Equity (₹ 100 each) 100 14
Reserves and Surplus 50 ?
Debentures 200 ?
350
The market value of equity share is ₹ 300 per share. The company uses market value weights for computing
average cost of capital. The corporate tax rate is 40 % while the average cost of capitalis 10 %.
What is cost of reserves and surplus, and cost of debt (before tax)?
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27.Cost of capital
From the following information find out the cost of debt capital (before tax and after tax) of a company:
(i) Weighted average cost of capital : 15%
(ii) Capital structure and cost of capital :
Source Amount (₹ /Lakhs) After-tax cost of capital
Equity share capital 1,200 17%
Reserve and surplus 200 ?
Debt capital 600 ?
2,000
(iii) Corporate Tax : 40%
28.Cost of capital
Swan Ltd. has assets of ₹ 3, 20,000 which have been financed with ₹ 1, 04,000 of debt, ₹ 1,80,000 of
equity, and a general reserve of ₹ 36,000. The company’s total profit after interest and taxes for the year
ended 31.3.2013 were ₹ 27,000. It pays 8% interest on borrowed funds and is in the 30% tax bracket. It has
1800 equity shares of ₹ 100 per share, presently selling at a market price of ₹ 120 per share. What is the
weighted average cost of capital of Swan Ltd.?
29.Cost of capital
AB Ltd. Has assets of ₹ 5,00,000 which have been financed by ₹ 3,00,000 of debt and ₹ 1,50,000 of equity
(share of ₹ 100 each) and a general reserve of ₹ 50,000. The firm’s EBIT (earning before interest and tax) for
the year ended 31st March 2005 are ₹ 45,000. It pays 10% interest on debt capital and is in the 40% tax
bracket. The company’s shares are selling at a market price of ₹ 200 each. Compute weighted average cost of
capital using market value as weights.
30.Cost of capital
The capital structure of a company is given below:
Equity share capital (5,000 shares of ₹ 100 each) ₹ 5,00,000
10% Preference share (2,000 shares of ₹ 100 each) ₹ 2,00,000
12% Debenture ₹ 3,00,000
₹ 10,00,000
Its operating profit is ₹ 2,90,000. The market price of each equity shares is ₹ 250 and of each preference
share is ₹ 125. Corporate tax to be 30% and Corporate dividend tax to be 10%. Compute WACC.
31.Cost of capital
The following information are available from the Balance Sheet of a company:
Equity share capital-20,000 shares of ₹ 10 each ₹ 2, 00,000
Reserve and surplus ₹ 1, 30,000
8% Debentures ₹ 1, 70,000
The rate of tax for the company is 50 %. Current level of Equity Dividend is 12 %. Calculate the weighted
average cost of capital using the above figures.
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32.Cost of capital
From the following information, determine the optimum capital structure (assuming tax = 50 %):
Debt % of total capital Employed Before tax cost of debt % Cost of Equity %
0 12 15
30 13 17
40 15 18
50 16 19
33.Cost of capital
Work out the marginal cost of capital from the following data:
Existing Capital: ₹ in Lakh Cost (%)
Equity 6000 15
Preference Capital 1000 10
Debt 4000 12
Retained Earnings 1000 18
Additional Requirement:
Equity 4000 18
Preference Capital 2000 12
Debt 3000 16
Retained earnings 1000 18
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Basic Concept (10 Marks)
Basic Concept [10 Marks]

1. Basic concept
Shubha invested ₹ 10,000 at an interest of 12% p.a. for 3 years Compute future value of investments
assuming interest is compounded quarterly. Given FVIF (3, 12) = 1.4262
2. Basic concept
Compute the compound value when ₹ 5000 is invested for 3 years and the interest on it is compounded at
12% p.a. quarterly.
3. Basic concept
A trader deposited ₹ 4, 00,000 in a bank @8% p.a. compounded interest for 5 years How much will he
get at the end of 5 years? [Compounded value of Re.1 for 5 years @ 8% p.a.=1.469]
4. Basic concept
Mrs. Sunita has ₹ 50,000 at her disposal. She wants to get her money doubled.
(a) If interest is compounded @ 12% p.a. annually, then how long she has to wait to fulfill her desire.
(b) If she is ready not to wait for more than 4 years then what should be the approximate rate of
compound interest?
5. Basic concept
A fixed deposit receipt has a maturity value of Rs. 1,33,100. What is the amount at which the fixed deposit
has been initially purchased if compound interest rate is 10% p.a. and the maturity period is 3 years
6. Basic concept
Naba is offered either to receive ₹ 5,000 one year from now or ₹ 7,000 five years from now. Which one
Naba will accept and why if discount rate is 10 %? Given, present value of Re 1 at 10 % are .909 and
.621 for 1st and 5th year respectively.
7. Basic concept
Mr. Y has two options:
Option A: Receive Rs. 40,000 two year from now Option
B: Receive Rs. 60,000 seven year from now
Which one should Mr. Y choose if the discount rate is 11%?What
option should be choose if the discount rate is 6%?
Comment on the results obtained in (a) and (b) above.
Given PVIF11%,2 = 0.812, PVIF11%,7= 0.482, PVIF6%,2=0.890, PVIF6%,7= 0.665
8. Basic concept
Mr. H is offered either to receive Rs. 10,000 three years from now or Rs. 14,000 five years from now.
Which are Mr. H accept? Assume rate of discount is 10%.
[Given: present values of Rs.1 at 10% are 0.75 and 0.621 for 3rd and 5th year respectively]
9. Basic concept
X borrows Rs. 59,36,000 from Y at a compound interest rate of 12% p.a. it is agreed that the loan shall be payable in
two equal instalments, which shall be payable at the end of the 1st year and 2nd year respectively. Calculate the
amount of instalments.
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10.Basic concept
You are approached by an insurance agent to buy an annuity of ₹ 50,000 for 6 years starting from the
beginning of first year. How much you should be ready to pay now for this annuity if you consider a
discount factor of 8% per annum?
11.Basic concept
You want to make a gift of ₹ 1, 00,000 to one of your friends after 4 years from now. What amount of
money you need to invest every year starting from the beginning of the first year so that you can get the
required amount 4 years? The normal return is 10%.
12.Basic concept
Mrs. Dasgupta has two options at the time of her retirement: Option
A: Receive ₹ 10, 00,000 as on the date of retirement. Option B:
Receive ₹ 1, 00,000 as an annual pension over 20 years. If the
discount rate is 12%, which option should she choose? [Present value
of 1 rupee @12% over 20 years is 7.469].
13.Basic concept
The present value of certain sum of money is more valuable than the future value of the same amount. –
Explain with reasons.
Dr. Kanjilal is given the following two options by his employer at the time of his retirement:
Option I –An annual pension of Rs. 50,000 as long as he lives
Option II – A lump sum payment of Rs. 3,00,000
If he expects to live for 15 years and his time preference for money is 12%, which option should he
choose
[Given PVIF12,15 =6.811]
14.Basic concept
Mr. X retires at the age of 60 and his employer given him two options :
Option one is a lump sum of Rs. 12,00,000 on retirement, and
Option two is to accept a pension of Rs. 1,50,000 per year for rest of his life. It is expected that he will
survive for another 15 years. If the rate of interest is 9% p.a. and PVIFA9%,15= 8.061, advice Mr. X
about his best alternative.
15.Basic concept
Mr. Sen estimates that he needs to withdraw Rs. 2, 40,000 every year from his bank for the next three years.
He wants to know the amount of deposit he should have in his bank today to meet the above requirement if
the rate of interest is 4% p.a. (Given PVIFA4%,3=2.775).
16.Basic concept
Mr. Bhattacharya borrows ₹ 15, 00,000 to buy a bungalow in Rajarhat. He wants to repay this amount in 15
equal annual instalments. The loan has been taken from a commercial bank which charges interest @ 10%
p.a. What is the amount of each annual instalment? [PVIFA10, 15 = 7.606]
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17.Basic concept
If the loan amount is ₹ 10 lakhs, tenure is for 3 years and rate of interest is 12%, find out equated annual
instalment. (PVIFA 12%. 3=2.40).
18.Basic concept
₹ 5,000 is paid every year for 10 years to pay off a loan. What is the loan amount if interest rate be
14% per annum compounded annually? Given PV (10, 0.14) = 5.21611
19.Basic concept
Y bought a TV costing ₹ 13,000 by making a down payment of ₹ 3,000 and agreeing to make equal annual
payment for 4 years How much would be each payment if the interest on unpaid amount be 14%
compounded annually? Given PV (4, 0.14) = 2.9137
20.Basic concept
Mr. Chiko is offered the following cash inflows:
End of year 1 2 3 4 5
Amount (Rs.) 15,000 20,000 32,000 20,000 18,000
Calculate the amount receivable by Mr. Chiko if he wants the whole amount at the end of 4th year.
[Applicable interest rate is 10 % p.a. compounded annually]
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Dividend Policies (10 Marks)
Dividend policies [10 Marks]

1. Dividend policy
From the following information, calculate value per equity share on the basis of Gordon’s Model. Earnings
per share ₹ 6, Internal rate of return is 30 percent and cost of capital is 10 percent. Dividend payout ratios
are 60% and 100%.
2. Dividend policy
The following information is acquired from XYZ Ltd. Net earnings -₹ 1,00,000. Equity Capital 5,000
shares of ₹ 10 each, cost of capital 10%, expected rate of return (i) 9 %, (ii) 10 % (iii) 12 %
Assuming the dividend payout ratios are 0%, 50% and 100% respectively determine the, effect of different
dividend policies on the share price of XYZ Ltd. for the above mentioned three alternatives levels of return
using Gordon's model.
3. Dividend policy
The earning per share of a company is Rs. 8 and the rate of capitalization applicable is 10 %. The
company has before it, an option of adopting (a) 50%, (b) 75%, and (c) 100% dividend payout ratio.
Compute the market price of the company’s quoted shares as per Gorden’s Model if the company can
earn a return of (a) 15% (b) 10% and (c) 5%.
4. Dividend policy
From the following particulars relating to R Limited determine the market price of a share using
Gordon’s Model:
Total Investment in shares ₹ 10,00,000
No. of shares 50,000
Total earning ₹ 2,00,000
Cost of capital 16 %
Dividend Payout ratio 40 %
5. Dividend policy
A company’s total investment in shares is ₹ 10,00,000. It has 10,000 shares of ₹ 100 each. Its expected rate
of return is 30 % and cost of capital is 18 %. The company has a policy of retaining 25 % of its profits.
Determine the value of the firm using Gordon’s Model.
6. Dividend policy
Given Earnings per share is ₹ 90. Calculate market price per share of a company using Gorden’s model
when dividend payout is (i) 30% and (ii) 60% assuming that:
(a) The company is a growth company (r > k) when r = 20%
(b) The company is a normal company (r = k) when r = k = 15%
(c) The company is a declining company (r < k) when r = 12%
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7. Dividend policy
From the following information calculate the market price of the share using Walter’s model:
Earnings Per Share (EPS) = Rs. 6, Internal Rate of Return (IRR) = 20 %, Cost of Capital = 10 %,
Dividend Payout Ratio (D.P. Ratio) = 80 %. Is it the optimum payout ratio? – Justify your answer.
8. Dividend policy
Z Co. Ltd. has an investment of ₹ 10,00,000 in equity share of ₹ 100 each. The profitability rate of the
Company is 16%. Pay out ratio is 80 %. Cost of Capital is 10 %. What will be the price per share as per
Walters Model ? Do you consider the given payout ratio as optimum ?
9. Dividend policy
The following data are available for N Ltd:-
Earning per share ₹ 3.00
Internal rate of Return 15 %
Cost of capital 12 %
If Walter’s valuation formula holds, what will be the price per share when dividend pay-out ratio is (a)50
%, (b) 75% & (c) 100 %.
10.Dividend policy
Determine the market value of equity shares of N Limited as per Walter’s Model:
Earnings of the company ₹ 5,00,000
Dividend Paid ₹ 3,00,000
No. of shares outstanding 1,00,000
Price earning ratio 8
Rate of return on investment 15%
Are you satisfied with the current dividend policy of the firm? If Not what should be the optimal dividend
pay-out ratio?
11.Dividend policy
From the following data, calculate the value of an Equity Share of each of the following three
companies according to Walter’s Model when dividend payout ratio is
(a) NIL, (b) 25% and (c) 75%
Companies M Ltd. L Ltd. N Ltd.
Internal rate of return (r) 15% 12% 10%
Cost of capital (K) 12% 12% 12%
Earnings per share (E) ₹10 ₹10 ₹10
What conclusion would you draw from your observation?
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12.Dividend policy
A company has 1,00,000 equity shares of Rs. 10 each. The company expects its earnings at Rs.
6,00,000 during the next financial year and its cost of capital is 10%. Using Walter’s Model, what dividend
policy would you recommend when the rate of return on investment is estimated at 8% and 12%? What will
be the price of each equity share if your recommendation is accepted?
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Capital Budgeting (20 Marks)
Capital Budgeting [20 Marks]

1. Capital Budgeting
The cost of a plant is ₹ 30,000. The expected life of the plant is 3 years !t is expected to generate EBD1T
(Earnings before depreciation, interest and taxes) ₹ 13,000, ₹ 15,000, ₹ 17,000 respectively. Compute
Accounting Rate of Return assuming 50 % tax, and straight line method of depreciation.
A company is considering an investment proposal to install a new machine at a cost of Rs. 50,000.
The facility has a life expectancy of 5 years with Rs. 5,000 salvage value. For the project additional
working capital of Rs. 10,000 will also be required. The applicable income tax rate is 30%. Estimated
EBDIT from the proposal are: Rs. 20,000; Rs. 22,000; Rs. 19,000; Rs. 17,000 and
Rs.24, 000 respectively for 5 years. Compute the Accounting rate of return for the proposal.
The cost of a plant is ₹ 60,000. The expected life of the plant is 3 years It is expected to generate EBDIT
(Earnings before depreciation, interest and taxes) ₹ 26,000, ₹ 30,000, and ₹ 34,000 respectively. Compute
Accounting Rate of Return assuming 30% tax and straight line method of depreciation.
X provides you the following information:
i. Purchase price of machine Rs. 5,00,000
ii. Estimated salvage value at the end of useful life Rs. 1,00,000
iii. Useful life 5 year
iv. Expected annual profits including depreciation and taxes for the next 5 years from the projects areRs.
75,000 and Rs. 1,75,000, Rs. 2,00,000, Rs. 2,00,000 and Rs. 50,000 respectively.
v. Tax rate 50%
vi. Depreciation is charged under straight line method.
Calculate the Accounting Rate of Return (ARR) of the capital investment
Beta Company is considering the purchase of one of the following machines, relevant data being
provided below:
Machine A Machine B
Original Cost Rs. 1,00,000 Rs. 1,00,000
Estimated Life 3 years 3 years
Earnings (after tax)
Year 1 Rs. 30,000 Rs. 20,000
Year 2 Rs. 50,000 Rs. 80,000
Year 3 Rs. 40,000 Rs. 40,000
The firm follows the straight line method of depreciation; estimated salvage value of both the
machines is zero. Determine the ARR of both machines.
uestions nswers 87
Gobind Kumar Jha
A project requires an initial cash outlay of ₹ 20,00,000 having a life of 6 years The expected average
annual profit from the project before tax is ₹ 545454. Compute the payback period of the project
assuming tax rate at 45% and the rate of depreciation at 10% p.a. on straight line basis.
A project of Rs. 3,00,000 is supposed to yield Rs. 40,000 after depreciation @ 12.5% and is subject to
income tax @ 40%. Calculate the payback period of the project.
Following information available for two machines:
X(₹) Y(₹)
Initial Investment 1,00,000 1,00,000
Life 7 years 10 years
Net cash inflow 25,000 20,000
Realisable value after 5 years 50,000 75,000
With the help of payback period method, evaluate the efficient one.
Compute the pay-back period for the project from the following information:
Cost of Assets – Rs. 100
Depreciation – 15% under straight line method
Profit after tax for the five years-
Year 1 – Rs. 15, Year 2 – Rs. 20, Year 3 – Rs. 25, Year 4 – Rs. 30, Year 5 – Rs. 35
10.Capital Budgeting
Compute the payback period for the project:
End of Year: 1 2 3 4 5
Book value of fixed assets: 90 80 70 60 50
Profit after Tax: 20 22 24 26 28
Compute payback period of a project of which the following details are available:
End of Year 1 2 3 4 5
Book value of Fixed Assets (₹ In Lakh) 450 400 350 300 250
Profit after Tax( ₹ In Lakh) 80 88 96 104 112
Project I costs ₹ 8, 00,000 and project II costs ₹ 12, 80,000. Both have a ten year life. Uniform cash receipts
expected from project I – ₹ 1, 60,000 and project II – ₹ 3, 20,000. Salvage value expected are project
I ₹ 5,60,000 declining at an annual rate of ₹ 80,000 and project II ₹ 6,40,000 declining at an annual
rate of ₹ 1,60,000. Which one is to be selected?
88 uestions nswers
83
CO. CLOUDY LTD. desires to invest in a project which requires an initial investment of ₹ 50,00,000. The
useful life of the project is 10 years with a salvage value ₹ 5,00,000 and will be depreciated on straight line
method. The profit before charging depreciation is ₹ 10,00,000 p.a. The income tax rate is 35%. Compute:
(i) Payback period (PBP) (ii) Average rate of return (ARR)
From the following information of MAK Ltd., calculate Pay Back Period:
(i) Purchase price of new machinery – ₹ 10, 00,000
(ii) Installation Expenses – ₹ 1, 50,000
(iii) Workers’ Training Expenses incurred to put the asset to use – ₹ 50,000
(iv) Subsidy from Govt. – 60% of Purchase Price
(v) Working Capital – ₹ 3, 00,000
(vi) Useful life of the machine – 5 years
(vii) Book salvage value – 10% of Purchase Price
(viii) Cash Salvage Value – ₹ 1, 20,000
(ix) Method of Depreciation – Straight Line
(x) Tax Rate – 30%
(xi) Sales units – 1, 00,000 units p.a.
(xii) Initial selling price per unit is ₹ 10 and variable cost is 40% of initial selling price. Annual
fixed cost other than depreciation is ₹ 2, 00,000.
B.T. Ltd. Wants to replace an obsolete machine to increase its productivity. There are two machines
under its consideration. The cost of machine I is ₹ 1, 40,000 and that of machine II is ₹ 2,20,000. The
company’s cost of capital is 16% and it expects the following cash inflow from each of the machines-
Year Machine-I Machine II Discounting
1 (₹) (₹) factor at 16%
1 - 60,000 0.862
2 40,000 72,000 0.743
3 95,000 85,000 0.641
4 80,000 80,000 0.552
5 50,000 60,000 0.476
On the basis of discounted pay-back period, which machine the company should purchase?

Using the information given below compute the Pay-Back Period under Discounted Pay-Back Method
Initial outlay ₹ 80,000
Estimated life 5 Years
Profit after Tax
End of year 1 ₹ 6,000
End of year 5 Nil
Depreciation has been calculated under straight line method. The cost of capital may be taken at 20%
p.a. and the P.V. Re. 1 at 20% p.a. is given below:
Year 1 2 3 4 5
P.V Factor .83 .69 .58 .48 .40
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84
Gobind Kumar Jha
L Ltd. provides you the following information:
a) Purchase price of machine Rs. 1,73,500
b) Useful life of machine 3 years
c) Salvage value at the end of useful life Nil
d) Cost of Capital 10%
e) Cash Flow after Tax (CFAT)
Year - 1 1,00,000
Year - 2 1,00,000
Year - 3 80,000
Note: Present Value factors @ 10% are as follows:
Year: 1 2 3
PV Factor: 0.909 0.826 0.751
Calculate the Discounted Payback Period.
Using the information given below Calculate the profitability of a project using (a) Payback Period
(b) Discounted Payback (c) NPV (d) P.I Method
Cost of investment ₹ 1, 00,000
Estimate life 5 years
Scrap Nil
Cost of Capital 10%
Profit after tax:
Year 1 - ₹ 5,000
2 - ₹ 8,000
3 - ₹ 10,000
4 - ₹ 12,000
5 - ₹ 9,000
Depreciation has been calculated under straight line method. The present value of ₹ 1, to be
received at the end of each year at 10% is given below:
Year : 1 2 3 4 5
PV : 0.91 0.83 0.75 0.68 0.62
Madhumita Ltd. Desires to invest in a project which requires an initial investment of ₹ 50, 00,000. The
useful life of the project is 10 years with a salvage value of ₹ 5, 00,000 and will be depreciated on
straight line method. The profit before charging depreciation is ₹ 10, 00,000 p.a. The income tax rate is
35%. Compute:
(a) NPV at 10% p.a. and
(b) P.I.
90 uestions nswers
ABC Ltd is considering their investment proposals. The Cash inflow after tax of three proposals are
given below:
Year Project A Project B Project C
₹ ₹ ₹
0 (20,000) (60,000) (36,000)
1 5,600 12,000 13,000
2 6,000 20,000 13,000
3 8,000 24,000 13,000
4 8,000 32,000 13,000
The cost of capital is 12%. You are required to select one of the projects on the basis of profitability
index.
Year : 1 2 3 4
Discounting factor : 0.8929 0.7972 0.7118 0.6355
Based on the following information, which project will you select and why.
Year Project I Project II Project III
Earning Depreciation Earning Depreciation Earning Depreciation
after Tax after Tax after Tax
1 20,000 3000 50,000 5000 35,000 4000
2 30,000 2000 40,000 4500 35,000 4000
3 40,000 2500 30,000 4000 35,000 4000
Assuming tax rate of 50% and discount rate as 10%
[Given : PV of Rs.1 at 10% discount Y1=0.909 : Y2=0.826 and Y3=0.751]
A machines costing ₹ 12, 00,000 is required in order to undertake a proposed project. The effectivelife
of the machines is expected to be 5 years with a residual value of ₹ 2, 00,000. The company follows
straight line method of charging depreciation. The estimated earnings before tax of the project are as
follows:
Year 1st 2nd 3rd 4th 5th
Earnings (₹) 4,80,000 5,60,000 6,40,000 4,00,000 3,20,000
before tax
If the tax rate is 40%, cost of capital is 15%, calculate the net present value and suggest whether the
machines would be acquired or not.
Given: The present value factors at a discount rate of 15% rate are:
Year 1 2 3 4 5
P. V. Factor 0.8696 0.7561 0.6575 0.5718 0.4975
uestions nswers 91
Gobind Kumar Jha
A Ltd. is considering an investment proposal which will require an initial investment of Rs. 2,80,000 in
fixed facilities and an additional Rs. 40,000 as working capital. The project is expected to generate cash
flows of Rs. 1,20,000. Rs. 1,00,000, Rs. 85,000, Rs. 95,000 and Rs. 90,000 respectively beforetax over
its 5 years lifetime. The estimated scrap value of the project is Rs. 25,000. The applicable tax rate is 40%
and the cost of capital is 10% p.a. Calculate the Net Present Value (NPV) of the project and advice on its
acceptability.
A company decided to start a project at a cost of Rs. 1, 20,000, part of which will be financed by long-
term debt. Following are the expected result for first year of the project.
Sales: 5000 units @ Rs. 50
Variable cost per unit Rs. 30 and Fixed operating cost Rs. 18,000 (excluding depreciation)
Depreciation: as per books of account = Rs. 20,000as
per Income Tax rules = Rs. 24,000
Interest on loan (to finance the project) Rs. 8,000 & Applicable tax rate 30%. You
are required to calculate net cash flow (NCF) for the first year.
Following figures relate to a new project for which a machine is to be acquired at a cost of Rs. 2,50,000and
initially Rs. 60,000 is to be invested as working capital:
Year 1 2 3 4
EBDIT (Rs.) 80,000 90,000 1,45,000 1,20,000
Depreciation (Rs.) 75,000 62,000 48,000 25,000
At the beginning of 2nd year, an amount of Rs. 10,000 is to be introduced as additional working capital. On
completion of project i.e., at the end of 4th year, it is expected that Rs. 40,000 will be realised fromsale of
scrap and working capital will be recovered in full.
Cost of capital is 12% and applicable tax rate is 30%. Calculate
NPV of the project and comment on its acceptability.
[Given the present value of Rs. 1 receivable at the end of each year for 4 years at 12% p.a. compounded
annually are 0.893, 0.797, 0.712 and 0.636 respectively.]
R. Ltd presently considering two machines for possible purchase. Other information related to the machinesare
as follows:
Machine 1 Machine 2
Purchase price ₹ 50,000 ₹ 60,000
Estimated life 4 years 4 years
Method of Depreciation Straight line Straight line
Estimated Scrap Value NIL NIL
Cash Flow before Depreciation & Tax
Year 1 ₹ 25,000 ₹ 45,000
Year 2 ₹ 25,000 ₹ 19,000
Year 3 ₹ 25,000 ₹ 25,000
Year 4 ₹ 25,000 ₹ 27,000
92 uestions nswers
87
Rate of Tax 40 %.
Compute net present value of each machine assuming Cost of Capital is 8 %. Which machine the company
should buy?
The present value of Re 1 at 8 % is as follows:
Year 1: 0.926; Year 2: 0.857; Year 3: 0.794; Year 4: 0.735
The management of M LTD. is considering investment project costing ₹ 1,50,000 and it will have a scrap
value of ₹ 10,000 at the end of its 5-year life. Transportation charges are expected to be ₹ 5,000 installation
charges are expected to be ₹ 25,000. If the project is accepted, a spare parts inventory of ₹ 10,000 must also
be required and maintained. It is estimated the spare parts will have an estimated scrap value after 5 years of
60% of their initial costs.
Annual revenue for the project is expected to be ₹ 1,70,000 and annual labour, material and maintenance
expenses are estimated to be ₹ 15,000, ₹ 50,000 are ₹ 5,000 respectively. The depreciation and taxes for
each of the five years will be
Year : 1 2 3 4 5
Depreciation : 72,000 43,200 32,400 21,600 800
Taxes: : 11,200 22,720 27,040 31,360 39,680
Calculate the net cash flows for each year and cost of the project. Evaluate the project @ 12% rate of
interest. The discount factors @ 12% are as follows:
Year : 1 2 3 4 5
Discounting factor : 0.8929 0.7972 0.7118 0.6355 0.5674
Should the project be accepted using NPV Method?
A company is considering an investment project which requires an initial cash outlay of ₹ 5,00,000 on
equipment and ₹ 20,000 as working capital. The project's economic life is 6 years An additional investment
of ₹ 50,000 each would also be necessary at the end of second and fourth year to restore the efficiency of
the equipment. The annual cash inflows expected from the project are:
Year Cash inflows (₹)
1 80,000
2 1,20,000
3 1,80,000
4 2,00,000
5 2,60,000
6 3,00,000
If the realisable scrap value of the equipment is ₹ 20,000 after 6 years and cost of capital is 20 %, justify
whether the project should be accepted or not by determining the net present value. Assume that working
capital will be recovered in full at the end of the project life.
Given That:
Year: 1 2 3 4 5 6
PV @ 20% 0.833 0.694 0.579 0.482 0.402 0.335
uestions nswers 93
Gobind Kumar Jha
A company has ₹ 40 lakh to invest at the cost of capital 15%. The following proposals are under its
consideration. Rank the projects on the basis of (a) NPV and (b) PI methods.
Project Initial outlay Annual Cash flow Life span
₹ ₹ ₹
A 2,00,000 50,000 10
B 1,40,000 40,000 8
C 60,000 16,000 10
D 1,20,000 30,000 12
E 1,00,000 24,000 8
Given that the present value of annuity of ₹ 1 at 15% are as under:
Year Present Value
8 4.6586
10 5.1790
12 6.1230
R limited is confronted with two mutually exclusive investment opportunities having following cash flows:
Proposal A : Initial outlay of ₹ 1,00,000 with net inflows of ₹ 25,000 at the end of first year and ₹ 1,25,000at
the end of second year.
Proposal B : Initial outlay of ₹ 1,00,670 with net inflows of ₹ 95,000 at the end of first year and ₹ 45,000 atthe
end of second year.
Rank the two investment opportunities in order of preference by the P.V. method and the IRR method.
Assume cost of capital to be 10%.
Discuss with reasons which of the two methods you would rely upon in arriving at your final choice in the
present case.
The relevant P.V. factors are given below :
K0: 10% 24% 25% 26% 27% 28% 29% 30%
Year1: 0. 909 0. 806 0. 800 0.794 0.787 0.781 0.775 0.769
Year 2: 0.826 0. 650 0. 640 0. 630 0.620 0.610 0.601 0.592
Comment:
Here, Proposal A and Proposal B are mutually exclusive projects i.e. only one project will be
accepted by the company. In such a situation, decision should be taken on the basis of NPV method.
The IRR method assumes that the cash flows generated from the projects are re-invested at internal
rate of return whereas NPV method assumes the investment of the cash flows at the rate of cost of
capital. Thus the NPV method is superior to IRR method in the sense that the former assumes the
cost of capital, rate for re-investment purposes which is uniform and can be applied for all
investments projects. But the IRR may vary widely from project to project. Thus the company
should accept Proposal A.]
Two machines are not identical in many respects. Following are the information regarding the two. The
estimated life of both machines is five years leaving no salvage value at the end.
Machine Cost (₹) Anticipated Cash flow after tax per year (₹)
Yr. 1 Yr. 2 Yr. 3 Yr. 4 Yr. 5
Machine M 6,25,000 - 1,25,000 5,00,000 3,50,000 1,50,000
Machine N 10,00,000 2,50,000 3,50,000 4,00,000 4,25,000 2,00,000
89
94 uestions nswers
The company’s cost of capital is 16%. You are required to make an appraisal of the two machines and
advise the company using (i) NPV and (ii) Internal rate of return.
End of Year 16% 18% 20%
1 0.862 0.847 0.833
2 0.743 0.718 0.694
3 0.641 0.609 0.579
4 0.552 0.516 0.482
5 0.476 0.437 0.402
From the information given below, determine the highest opportunity cost (IRR) that the project can bear :
(i) Required initial investment in fixed facilities : ₹ 10,000.
(ii) Profit before depreciation & Tax expected to generate by the project during the 4 years of its economic
life:
End of
1st year : ₹ 4,000
2nd year : ₹ 6,000
3rd year : ₹ 8,000
4th year : ₹ 2,000
(iii) No scrap value at the end
(iv) Appropriate tax rate : 40%.
(v) Fixed facilities are allowed to be depreciated on straight-line basis for tax purposes, (vi) Relevant
Year : 1 2 3 4
P.V. factor @ 20 % : 0.833 0.694 0.579 0.482
P.V. factor @ 22 % : 0.820 0.672 0.551 0.451
@ 23 % : 0.813 0.661 0.537 0.437
@ 25 % : 0.800 0.640 0.512 0.410
An investor facing two mutually exclusive investment proposals having life span of four years each
furnishes the following information:
Project A Project B
Initial Investment needed ₹ 80,000 ₹ 24,000
Net after tax inflows expected
At the end of year 1 ₹ 28,000 ₹ 9,800
2 ₹ 28,000 ₹ 9,800
3 ₹ 28,000 ₹ 9,800
4 ₹ 28,000 ₹ 9,800
You are asked to rank the two proposals by the NPV method and the IRR method assuming cost of capital
to be 10%. Explain the reasons for contradiction in ranking, if any, and state with reasons which of the two
methods the investor should rely upon in making his final choice.
uestions nswers 95
Gobind Kumar Jha
A company is considering two mutually exclusively projects X and Y. following details are made
available to you: Project Cost = 3500
Year Project X (Rs. In lakh) Project Y (Rs. In lakh)
Year 1 500 2500
Year 2 1000 2000
Year 3 1500 1000
Year 4 2250 500
Year 5 3000 500
Assume no residual values at the end of the fifth year. The firm’s cost of capital is 10%. You are
required to calculate the following in respect of the two projects –
(a) Net present value, using 10% discounting;
(b) Internal Rate of Return
(c) Profitability Index.
Present value of Rs. 1 at 10% discount rate Y1 -.909, Y2 - .826, Y3 - .751, Y4 - .683, Y5 - .621.
A company is exploring the proposals of replacing its existing machine which is unable to meet the
production schedule to match the rapidly rising demand of its product. The company has two options: either
to overhaul the existing machine at a cost of Rs. 30 lakh or to go in for a New Machine with higher capacity
at cost of Rs. 48 lakh. Both the machines are expected to be operational for 5 years.
The expected cash flows from these two alternatives are as follows:
Year Cash Inflow (of Rs. In lakhs)
Overvalued machine New machine
1st year 5 12
nd
2 year 6 16
3rd year 24 20
th
4 year 16 20
5th year 14 18
Total 65 86
The cost of capital to be considered is 10%.
You are required to appraisal the two alternatives with the help of (a) Net Present Value and (b) Discounted
Pay Back Period Method. Present Value of Rs. 1 at 10% discount rate are as follows:
Year 1 2 3 4 5
P.V 0.91 0.83 0.75 0.68 0.62
Given below are the information relating to some projects:
Projects A B C D E F
NPV (Rs.) 2,20,000 (15,000) 1,40,000 1,62,000 76,000 64,000
Profitability Index 1.22 0.95 1.20 1.18 1.19 1.16
Suppose the firm has a budget ceiling of Rs. 20,00,000. Advise the firm on selection of projects assuming
that the projects are not divisible.
S. Ltd. is planning its capital investment programme for next year. It has 4 proposals all of which gives a
positive NPV at the company cut off rate of 12%. The required initial capital outlay and present values are
as follows:
96 uestions nswers
91
Proposals Initial Capital Outlay NPV (@ 12%) Profitability Index

(Rs.)
X1 2,25,000 67,500 1.30
X2 1,00,000 45,000 1.45
X3 1,50,000 60,000 1.40
X4 1,75,000 64,750 1.37
Which proposals the company should accept? Assume that the proposals are indivisible and there is no
alternative use of the money allocated for capital budgeting.
Reliance Industries Ltd. Has an Investment budget of ₹ 10 lakh for the current year. It has short listed
two projects X and Y. Further particulars regarding them are given below:
Project X Y
₹ ₹
Investment required 10,00,000 9,00,000
Average estimated cash inflows before depreciation and tax 2,40,000 2,05,000
Salvage value is assumed to be nil for both the projects after the estimated life of 10 years are being over.
The company follows straight line method of charging depreciation and tax rate is 35%. Assuming cost of
capital to be 12%, find out the
(a) NPV of both the projects and
(b) IRR of both project X and project Y.
Given PV of an annuity of ₹ 1 for ten years at different discount rates:
Rate (%) 10 11 12 13 14 15
Annuity value for 10 years 6.1446 5.8992 5.6502 5.4262 5.2161 5.0188
An enterprise can make either of the two investments at the beginning of 2016. Assuming a requiredrate
of return at 10% p.a., evaluate the investment proposals under each one of the following criteria;
a) Return on Investment
b) Discounted payback period
c) Profitability Index.
The forecasted figures are:
Investment Cost of Estimated Scrap Net Income (after Depreciation and tax at
Proposals Investment Life Value the end of year)
Year Rs. 2016 2017 2018 2019 2020
Rs. Rs. Rs. Rs. Rs.
P Rs. 40,000 4 NIL 1,000 4,000 7,000 5,000 --
Q Rs. 56,000 5 NIL NIL 6,800 6,800 6,800 6,800
It is estimated that each of the alternative projects would require an additional working capital of Rs. 4,000,
which would be received back in full after the expiry of each project. Depreciation is provided under
straight line method.
uestions nswers 97
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Calcutta University

B.Com (3rd Year)

Question & Answers

Working Capital Management 54 - 62

1. Define Financial Management.

2. Discuss the importance of Financial Management.

3. What are the functions of financial manager/Financial Management?

5. Discuss the nature of financial management.

6. What are the objectives of financial Management?

10. What are Limitations of ‘Maximisation of Profit’ as the objective of a firm.

11. Distinguish Between Profit maximization & wealth maximization

Profit Maximisation Wealth Maximisation

15. Define risk. Classify risks associated with financial management.

16. Discuss the relationship between Risk and Return.

19. What are the process (Steps) of capital budgeting?

21. Discuss briefly the NPV method of evaluation of projects.

22. Discuss briefly IRR method of evaluation of projects.

25. Write short note on Accounting Rate of Return Method.

26. Write short note on Profitability Index Method.

27. Modified Internal Rate of Returns (MIRR)

28. Write Short Notes on Capital Rationing

B. Com (Hons.) 2017

1. Discuss the nature and objectives of financial management.

Project I Project II Project III

Year Earning Depreciation Earning Depreciation Earning Depreciation

1 20,000 3,000 50,000 5,000 35,000 4,000

2 30,000 2,000 40,000 4,500 35,000 4,000

3 40,000 2,500 30,000 4,000 35,000 4,000

Assuming tax rate of 50% and discount rate as 10%.

[Given: PV of 1 at 10% discount Y, 0.909; Y, 0.826 and Y, 0.751]

Equity Shares Capital (10 lakh shares) 100

Retained Earnings 130

14% Debentures (70,000 debentures) 70

16% Term Loan 100

B. Com (Hons.) 2018

1. Discuss the three broad areas of financial decision making.

The company is limited to a capital spending of Rs. 3,00,000.

6. L. Ltd. provides you the following information:

(a) Purchase price of machine ₹1,73,500

Raw Material storage period 45 days

(ii) Number of Operating Cycles in a year.

Production and sales 1600 units

Financial alternative: Plan

(b) X Ltd. opts for the following capital structure:

B. Com (Hons.) 2019

3. Mr. X needs 1,00,000 at the end of 10 years. He has two options:

Option 1: Deposit some lump sum amount today at 6% rate of interest.

You are required to:

(a) Find out the amount to be deposited under Option 1 today.

Year Cash flow stream (₹ in lakh)

P.V. of ₹1 at 10% to be received at the end of each year is as below.

(a) Annual cost saving 96,000

(i) Cost of the project (ii) NPV of the project

PVIFA (15%) 3.353

(b) Write a short note on the recommendation of Chore Committee.

Year 10% 12% 14%

(b) Comment on the financial position of the companies.

Type of capital Book value Market value

12. (a) Explain the term 'Dividend' and 'Dividend Policy'.

Earnings of Company ₹5,00,000

B. Com (Hons.) 2020

2. Discuss Matching and aggressive approaches in the context of Working Capital.

Earnings of the Company ₹10,00,000

• Applicable corporate tax rate 30%

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